Leeham News and Analysis
There's more to real news than a news release.
Leeham News and Analysis
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Boeing: program charges right course to de-risk finances
Dennis Muilenburg, CEO The Boeing Co.
July 27, 2016, © Leeham Co.: Boeing officials termed charges against the 787, 747-8 and KC-46A as the right course while reaffirming the underlying strength of the company.
CEO Dennis Muilenburg said the charge against the 787 was the right decision to reduce the financial risk going forward.
He also said the write down of the remaining deferred production costs of the 747 significantly de-risk the program. Boeing reaffirmed its belief in the future of the program, despite challenges with the cargo market.
Despite continued charges against the tanker, Boeing saw the first flight of the first production aircraft during the year.
Continued cargo weakness
Muilenburg said that the cargo market remains weak, with demand down 1% YTD. “This segment of the market remains challenging,” he said.
He said that overall demand is such that Boeing will produce more than 900 airplanes a year by the end of the decade.
For the full year, Boeing targets about 40 777 orders. There have been eight net orders.
Boeing sold out about 60% of the delivery slots in 2018 at the planned production rate of 5.5/mo, Muilenburg said. The slots remain at 80% sold out in 2017, which has held steady for about a year.
Boeing continues to plan for increased 737 production rates of 47/mo in 2017, 52/mo in 2018 and 57/mo in 2019. Despite the increased rates, Muilenburg said Boeing remains oversold.
Share buybacks
Greg Smith, CFO of The Boeing Co., said the company expects to complete $8.5bn in stock repurchases over the next two years. Boeing repurchased $6bn in shares YTD.
Smith said the company remains committed to returning money to shareholders and investing in new development and de-risking the company.
Q&A
Quotes may be paraphrased.
- The accounting block for the 767 program has been extended, though Boeing didn’t say by how much. 787 deferred production is improving, with the 787-9 and 787-10 leading the way. “It’s all about cash,” said Smith. “The fundamentals of the 787 cash program remain intact.”
- The rescheduling of supplier payment terms is back to the fundamentals of how Boeing manages its capital, Smith said. Payables have gone from daily to twice a month in keeping with industry standards. Boeing wants to get this to quartile payments, which Smith also labeled as industry standards. Muilenburg said this is not a one-time event, but part of a long-term plan.
- There are now 60 airlines for 2,200 aircraft enrolled in services agreements. This is a long-term growth in the services business.
- On 777, we understand the reality of where we’re at. The fact is YTD we have net orders for eight 777s against a target for 40. The wide-body market is clearly a challenging place right now. In case orders don’t materialize, we’re going to keep supply and demand in balance. Regardless of how the scenario plays out on 777, we will still be producing over 900 airplanes by the end of the decade. In the long-term, the wide-body demand is still attractive. In the 2020 decade, there will be a large demand for replacement aircraft.
- Muilenburg said BCA margin goals remain toward double digit next year. There is still work to make that sustainable. Toward the end of the decade, the goal remains at mid-teen. Improving productivity and cutting costs, block extensions on programs are accretive to margins as well. We still have a lot of work to do across the supply chain. We will be relentless there as well. Smith added that we’re looking at market-based across the board, internally and externally. The majority of this is outside the company. “This is a clear and enduring focus for us,” Muilenburg said. “We’ll match production to demand” for the 777, said Smith.
- There is work to fill out to rate 14 on the 787, Smith said. [This means more orders are still needed.—Editor.] Going to rate 14 would add six months to deferred production costs. Rate 14 us an end-of-decade target. Manufacturing commonality between the 9 and 10 is north of 95%, says Muilenburg.
- 787 is sold out through 2018, with a few positions open in 2019. 2020 open, Muilenburg said.
- 787 broke even on a cash basis on a unit basis late last year. Mix is a big play going forward. Dash 9 and 10 are big drivers going forward. [Note no reference to -8.-Editor.)
- Muilenburg said entry-into-service for the MAX is probably going to be in the 1H2017 rather than 3Q2017. This is a good example of how we can and should perform, he said. This is about disciplined innovation, on cost and on schedule. We’re taking lessons learned from MAX and deploying them into 787-10 and 777X.
- Muilenburg said Boeing still targets a 1:1 book:bill this year. The market is more favorable to narrow-body this year. There is no need to make “drastic” changes to pricing for market share. There is some hesitation to buying wide-body airplanes but the value proposition holds up “very well.”
Dear Scott, I have three questions for your consideration, please. One, are we sure from Boeing’s comments, that all significant capitalized 747-8 costs have now been written off? (And what about eventual 47 line shutdown/conversion costs? Will that be another separate, significant charge amount?) Two, how can Boeing, under GAAP accounting rules–and with a presumable blessing from its CPAs–have written off $847 million AFTER TAX, on two 787s with a probable, maximum market value of $150 million a piece, or $300 million PRE TAX? And three, how does a relatively quick, straightforward KC-46 boom pressure relief valve addition, and related testing and production line/tooling changes result in, what looks like to me, a staggering $350 million (pre tax) charge? Thanks in advance for any reasoned insight you might provide on these. MontanaOsprey
Montana: Several Wall Street analysts believe more charges of $330m-$370m could be coming. Can’t answer questions 2 and 3.
Thanks, Scott. I’ll see if any of the analysts on the earnings call tried to get answers on the two unanswered.
I think you are taking the last two unsold ‘terrible teens’ as the only source of that write off. My take is that it covered that whole group (12) including the 10 that were sold after rework. They havent itemised the losses but clearly two unsold would be the largest share. Now that every single one of that group of 12 has been disposed the accountants clear the numbers in the books.
Remember that as early production aircraft have an outsize cost before the learning curve cuts in.
No. excess production cost for marketable items goes into deferred cost ( and an intermediate stint in inventory already deviating from “inventory cannot have value over and beyond the market value)
Marking those two frames as not marketable and thus removing them from the accounting block releases the deferred amount of production cost into the present.
Sorry, I don’t know how to “hot link” it, dukeofurl, but please see the Boeing July 21st press release. Boeing specifically states in this release that the $847 million AFTER TAX write-off ties to only the two 787 test aircraft not being reworked for sale. Uwe, sorry I can’t reply directly to you, but it’s my contention (per GAAP accounting rules), any and all cost above the assets’ market value (net realizable value) on inventory items should NEVER have been booked into deferred production costs. It should have been–ideally–charged off years ago when incurred. Or, going out on a limb, and, if they could get their CPAs’ blessing, the costs might have been acceptably booked into deferred R&D. Why does it matter? Well because I don’t believe it conforms with GAAP, and, as such, could further open the door to questioning Boeing’s other accounting practices, its overall accounting and financials! And finally, as far as we know, there’s still an active SEC Boeing investigation, there’s Sarbanes Oxley law, and this is a time of shareholder class action litigation–if there’s material financial misstatement.
Planes don’t cost what you think they cost to make. In particular the learning curve applies, where roughly speaking you look at how much the n’th item off the assembly line cost to make and compare it to the double-n’th item – such as number 5 versus 10, 10 versus 20, 100 versus 200 etc. In general in aviation you’ll find the latter costs 85% of the former. This is logical – the more you do something, the better you get at it. It also means the first planes made cost *way* more to make than further down the line, which is one way they can come up with these huge charges, especially if they are now acknowledging they’ll get zero for the planes.
Javier has several good articles about this, including working out the learning curves for the 787. Recommended reading at https://theblogbyjavier.com/tag/learning-curve/
Phew, now that is into the accounting weeds.
How can one not expect a further 777-300ER production reduction? 2016 1st half sales is only 8, of 48 full year sales required to keep the line going at current rate. The widebody order slump appears to have prematurely ended the 300ER’s fantastic run.
To answer my own question, Boeing must be offering huge discounts, which will lower profits, and lose 9/8 sales.
What is the cost to make a 787-8 that is 95% compatible with the -9 & -10?
Will they just let it be discontinued and fill it in with the MOM airplane project? Is the cost just too much?
Its essentially much the same cost to make all the 787 types ( yes there some extra fuselage sections), they are just ‘creating value’ so they can charge more for the bigger planes.
Scott tells us that its not feasible as the 787-8 is so far out of commonality with the -9 and 10 its essentially a train wreck, will not sell in the future and not worth putting any money into it.\
Should be a thrill for the Maint on it.
I don’t recall the exact figure but maybe 40% or less. I was shocked.
It seems nuts but then what do I know.
It sounds like that in a way the 787 was two development programs and not one. Not really surprising the expense when you think of it that way.
There is no 95% commonality from -8 to -9/-10.
It is much, much lower.
IMU Boeing would be happy to discontinue the -8 aka 787 Mk1
No they can’t as its their offering for the A320 sized market.
The resized 737-7 is a clever upsizing as before the head to head competition of the A320 and 737-8 meant Boeing was giving away the extra capability of range and passengers to match the A320s price.
Now they can say the 737-7 is close to the A320 in capability and price too, so they can ask and get a premium for their 737-8.
“Muilenburg said entry-into-service for the MAX is probably going to be in the 1H2017 rather than 3Q2017. This is a good example of how we can and should perform, he said. This is about disciplined innovation, on cost and on schedule.”
When Boeing announced the 737 MAX in 2011 it was not long after the 787 debacle. IIRC, they said at the time that they had set an EIS date that they were sure to be able to meet, and that if everything worked well there was a good chance they would end up being ahead of schedule. When they announced that target date back then I thought it was a ridiculously long development period for a simple upgrade like the MAX. Well, I am not impressed at all. Nor anyone else I suppose, except perhaps for Muilenburg. The MAX project was approved almost five years ago. Think at what stage of development the NSA would be today if it had been launched at that time instead of the MAX. I don’t think it’s such a good example of how they “can and should perform.” And I don’t think it has anything to do with “discipline innovation” either. I am sad to see the 747 go, which was once Boeing’s pride. But I would be joyful to see the 737 go, which has become Boeing’s shame.
Well, it appears the 737 is the only plane left that is profitable for Boeing.
If they announce a successor, sales would soften significantly and leave the company deep in the reds.
Not a very enviable position to be in.
“Not a very enviable position to be in.”
It’s a typical “damn if you do, damn if you don’t” kind of situation. Your “deep in the red” scenario is perfectly valid. But I also believe that my own scenario is valid as well. It goes like this: The 737 order book is at a record high. This creates the illusion that the 737 is at the top of its game. Perhaps it is, but it can only go downward from here because of the new competition. The duopoly we are in right now will not last for ever and Boeing will suffer more from this new situation than Airbus will, simply because the 737 is no longer competitive with only one attractive model, the MAX 8. This makes the 737 current business model unsustainable and we can therefore expect a sharp drop in orders in the coming years. I believe we will see from now on a B2B ratio below 1, year after year, until Boeing will have no other choice but to replace the venerable 737. And because of the unfavourable timing for Boeing (what I like to call bad convergence) this fast evolving situation may very well “leave the company in the red” as you say. We are already seeing signs of this, but I don’t expect Boeing to be in trouble until the beginning of the next decade. This may appear to be still quite far in time but in commercial aviation the business cycles, as well as the development cycles, are extremely long.
Yes the horrible shame that has sold over 3000 units.
Selling items does not come with intrinsic “automatic” profits.
Just look at the 787, they have to sell something north of 1500 maybe even 2000 to ‘make a profit’
So you are asserting they are not going to make a profit on the MAX? Really?
It was just to indicate some programs sell large numbers but arent even paying to keep the lights on yet. The 787 comes to mind.
The new 747-8 is obviously selling every unit at a loss- otherwise they wouldnt be taking charges in the accounts.
the 737 max is a different category as all the development, apart from a relatively small amount, has been done by the engine maker. The risk there is the end of line old models will have to be sold at a loss or zero profit, as we saw with the order with United.