Leeham News and Analysis
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Leeham News and Analysis
- Dissecting Boeing CEO’s statement next new airplane will cost $50bn April 15, 2024
- Bjorn’s Corner: New engine development. Part 3. Propulsive efficiency April 12, 2024
- A350-1000 or 777-9? Part 2 April 11, 2024
- Pontifications: Boeing “transparency”–not so much. April 9, 2024
- Airbus charges and write-offs since 1999: more than €33bn April 8, 2024
HOTR: Boeing warns of forward losses on 787, 777X programs
By the Leeham News Staff
Aug. 5, 2020, © Leeham News: In another demonstration of the negative impact of the COVID-19 crisis, Boeing warned that two flagship airplane programs could face forward losses.
Neither the 787 nor the 777X are in forward loss positions yet. A forward loss means Boeing won’t make money on the program.
Despite the 787 incurring more than $30bn in deferred costs, Boeing hasn’t taken a write down. The deferred costs have been burning off since 2015. Other programs have been subjected to forward losses, including the 747-8, VC-25 (Air Force One) and the KC-46A tanker.
But with the production reduction of the 787, down to 6/mo in 2021, Boeing now says there is a risk to a forward loss.
10Q Statements
In the Second Quarter 10Q filed last week after the earnings call, Boeing stated:
787 Program
During the second quarter of 2020, we experienced significant reductions in deliveries due to the impacts of COVID-19 on our customers as well as travel restrictions and the temporary suspension of production operations in the Puget Sound area and South Carolina. Pre-COVID-19, we were producing at a rate of 14 per month and had planned to adjust the 787 production rate to 12 per month in late 2020 and to 10 per month in early 2021. Due to the impacts of COVID-19 on customer demand, we are currently producing at a rate of 10 per month and plan to reduce to 6 per month in 2021. As a result of the planned production rate changes, we reduced the accounting quantity for the 787 program by 100 units during the first quarter of 2020. The 787 program has near breakeven gross margins due to the reductions in the production rates and the reduction in the program accounting quantity. If we are required to further reduce production rates or experience other factors that could result in lower margins, the program could record a reach-forward loss in future periods.
The 777X is the other program Boeing warned could face a forward loss. Accounting blocks aren’t determined until the first delivery, which now is set for 2022.
777 Program
In 2013, we launched the 777X, which features a new composite wing, new engines and folding wing-tips. We have experienced issues in engine design and development on the 777X. The first flight of the 777X was completed on January 25, 2020, and first delivery is now targeted for 2022. The 777 and 777X programs have a combined production rate of approximately 5 per month gradually reducing to 2 per month in 2021. We expect to deliver at an average rate of approximately 2.5 per month in 2020.
Market uncertainties driven primarily by the impacts of COVID-19 are resulting in lower planned production rates and creating significant pressure on the 777X program’s revenue and cost estimates. Based on our assessment of the probable range of initial accounting quantities, the 777X does not have a reach-forward loss at June 30, 2020. The level of profitability on the 777X program will be subject to a number of factors. These factors include continued market uncertainty, the impacts of COVID-19 on our productivity as well as impacts on our supply chain and customers, production rate adjustments for other commercial aircraft programs, and potential risks associated with the testing program and the timing of aircraft certification. One or more of these factors could result in a reach-forward loss on the 777X program in future periods.
Overhead absorption
Note the reference to “production rate adjustments for other commercial airplane programs.”
For the unfamiliar, one may ask why rates on other programs (in this case, the 787, 747-8 and 767/KC-46A) may affect the 777X program. It’s unclear how rates for the 737 MAX, in Renton, might apply to Everett cost allocation.
The wide-body airplanes are produced in the Everett (WA) facility. The cost of running this facility is allocated across all four programs. This is called “overhead absorption.” How Boeing allocates other costs (such as administration, services, etc.) per program is also a factor.
If production rates go down, absorption costs go up. Thus, if Boeing shifts 787 production from Everett to Charleston, the costs associated with the Everett 787 line must be absorbed by the other three lines. With the 747-8 disappearing in 2022, these costs must be adsorbed by the other lines.
No decision has been made about consolidating the 787 line into Charleston, so, for now, these costs presumably remain with the 787. But shifting production and the closure of the 747 line may shift enough costs to the 777 and 767/KC-46A to throw these programs into a loss. (The KC-46 already is a forward-loss program so far.)
Boeing explains this succinctly when talking about the KC-46A.
“An increase to the reach-forward loss on KC-46A Tanker of $151m in 2020 primarily [was] driven by additional fixed cost allocation resulting from lower commercial airplane production volume due to COVID-19….”
737 MAX
Despite an estimated $19bn in costs related to the MAX grounding and accidents, this program is not in a forward loss position or at risk, so far. With a backlog of 3,500 aircraft (and several hundred more under a risk-accounting requirement called ASC 606), Boeing is expected to have a profitable program unless another series of disasters affects customer ability to take delivery.
The firm Melius Research, in a note issued Monday, highlighted the current financial outlook on the MAX.
“With respect to the $6.7Bn in customer settlements that still need to get paid out (of the total $9.3Bn accrued to date), $3.1Bn have now reached initial “agreements” awaiting finalization,” Melius writes. It summarizes:
- $1.1Bn will be settled in cash;
- $1.9Bn will be settled with lower “delivery payments” (i.e. lower final payments upon delivery);
- $0.1Bn will take the form of “other concessions;” and
- $3.6Bn will be determined following negotiations with customers.
Returning to the 10Q
Boeing also wrote in its 10Q:
Additional Considerations
The development and ongoing production of commercial aircraft is extremely complex, involving extensive coordination and integration with suppliers and highly-skilled labor from employees and other partners. Meeting or exceeding our performance and reliability standards, as well as those of customers and regulators, can be costly and technologically challenging. In addition, the introduction of new aircraft and derivatives, such as the 777X, involves increased risks associated with meeting development, production and certification schedules. As a result, our ability to deliver aircraft on time, satisfy performance and reliability standards and achieve or maintain, as applicable, program profitability is subject to significant risks. Factors that could result in lower margins (or a material charge if an airplane program has or is determined to have reach-forward losses) include the following: changes to the program accounting quantity, customer and model mix, production costs and rates, changes to price escalation factors due to changes in the inflation rate or other economic indicators, performance or reliability issues involving completed aircraft, capital expenditures and other costs associated with increasing or adding new production capacity, learning curve, additional change incorporation, achieving anticipated cost reductions, flight test and certification schedules, costs, schedule and demand for new airplanes and derivatives and status of customer claims, supplier claims or assertions and other contractual negotiations. While we believe the cost and revenue estimates incorporated in the consolidated financial statements are appropriate, the technical complexity of our airplane programs creates financial risk as additional completion costs may become necessary or scheduled delivery dates could be extended, which could trigger termination provisions, order cancellations or other financially significant exposure.
That 777X statement reads to me that they are less than 50% confident of avoiding reach forward losses but were determined (and reasonably so) not to say it.
Also, I find the choice of “appropriate” in “While we believe the cost and revenue estimates incorporated in the consolidated financial statements are appropriate” interesting. In a situation like this I’d have more confidence if I read a more objective descriptions such as “representative” rather than a more subjective “appropriate”.
Well the Boeing CFO is now the head of Strategy AND Communications.
Boeing recently assigned Marine guys (Chun, Golightly) to do Communications. How did they handle the Lion Air crash?
So, Boeing ramp up production and use the anticipated unit cost reduction to cut prices to try to kill the competing Airbus product….
….and then it all goes horribly wrong – memories of the late 90s anyone?
This doesn’t sound good. If the 737, 777X, 787 and KC46 are in trouble, F18, F15, Chinook, Apache are getting real old (>45 yrs) , what puts bread on the table for the next 5 years?
Maybe a radical review of long term company strategy is finally on the table. This was born way before Covid-19. The aging portfolio, certification problems, corporate greed, congress lobbies, short term phocus, arrogance.
Airbus has won for now, better products, better strategy. Accept & regroup.
New leadership is required, for change they better scan the world for the best team, instead of the old boys network.
Succinct, and well stated. Trouble is, I still own the stock.
Did you buy at a price lower or higher than its current price?
If you didn’t have the stock would you buy it now at it’s current price?
Oddly, the F-15 is now FBW/upgrade4d and in grand shape thanks to orders from Saudi Arabia and Quatar (I believe) – USAF has order 200 (will see) to replaced aged out F-15C/D models.
F-18 has been revised (upgrade4 and has orders from Navy to fill in the the missing F-35 (Lockeheeds wonder offering to the world)
Apache and Chinook, continue to get new orders with an offering for Chinook of Upgraded P&W engine or a new GE engine.
How that fares when the current regime is overthrown is hard to tell.
@ Julian.
BA has got to be one of the most widely head stocks: in ETFs and Funds. They used to say: So goes GM, so goes America. I don’t know if Boeing reached that status, but it is/was the country’s largest exporter. Held it for years and bought more recently…
Actually, on the military side, Boeing situation significantly improved in the last few years. The US Navy just ordered 78 F/A-18E/F Super Hornet Block III and the US Air Force is in the process of ordering up to 144 F-15EX (as a replacement for the F-15C) and potentially may order even more (as a replacement for the F-15E). In addition, Kuwait ordered 28 F/A-18E/F Super Hornet while Germany order 30 F/A-18E/F Super Hornet + 15 Growler. Qatar also ordered 36 F-15QA.
A few years ago, there was a serious discussion about shutting down the F-15 and F-18 production lines due to lack of orders. Now, there is enough order for at least 5 years if not more if Boeing wins more export orders or if the USAF and USN decide to increase their order of F-15/F-18.
Contrary to what TW said above, the Navy wants to halt new production of the F-18 Super Hornet after the current order, so that Boeing can shift to upgrading existing F-18 aircraft to the latest block. That contract will involve a lot more aircraft and is potentially quite lucrative for Boeing.
The F-35 is coming online now, and together with new F-18’s, will displace the older F-18 units for overhaul. The Navy’s goal is not to be down more than 40 aircraft (out of 800) at any one time.
That should be possible, with the additional F-18’s and F-35’s. The final mix will be about 3 to 1 F-18 to F-35. So Boeing will be supporting a 600 aircraft F-18 fleet for the foreseeable future.
I would add that the US Navy plan to update almost all Super Hornet Block II to the block III standard, that is about 400-500 aircraft. This is a multi-billion contract. In addition to the 78 Super Hornet Block III ordered by the US Navy, the 28 Super Hornet ordered by Kuwait, and the 45 Super Hornet/Growler order by Germany, there are still several other potential customers including Canada, Finland, and India. In one sentence, things are going pretty well for Boeing Defense and Space.
Rob:
What part about FA-18 production do you not understand?
I did not say E/F, just that fill in for the missing F-35C – whatever build spec they agree with and to.
Same with the F-15, its not the old F-15, its the new FBW that is basically a Saudi latest gen F-15 which is hugely upgraded.
TW, my point was that the F-18 orders are not to fill in for missing F-35’s. The plan has always been to have a mix, and the orders for both aircraft are consistent with that plan.
The Navy will order only about 240 F-35’s total, including training aircraft The current rate for F-35c production is only about 20 per year, that could decline with COVID, and must be shared with the Marines. That will increase when full-rate production is authorized.
What is true, is that the Navy accelerated purchase of the Super Hornet until the F-35c was available in greater numbers, so they could replace the retiring original Hornets. But the balance will come out to be the same.
Also of interest, the first pilots based in F-35 squadrons have graduated from Top-Gun with their aircraft. The officers had previously graduated with the Super Hornet. A new curriculum has been created for the F-35 capabilities, and integrating them with the F-18 and EA-18.
Still the old plane built to 1970 design standards. Adding FBW to an existing airframe isnt a big deal ( the software is the hard part) but doesnt give you all the advantages that later FBW from scratch does.
Really?
Ever hear of the A300?
How soon they forget – or selective memory
The 737MAX should be very profitable once volumes kicks in. The 777X as a freighter should be the industry standard eventually if Boeing does it right. KC46A might become the KC46B with new GEnX Engines and higher prices. The F18G Block III has some features making it the US Navy standard Aircraft and most likely for some other navies that want 2 Engines over water. The F-15EX might be the “big brother of the F-35” as the F-35 is mainly a bomber/air battle commando central and need the fast and long range F-15 carrying heavy loads.
So some countries already have both like US, Israel, Japan, Korea are set besides some upgrades to the F-15’s, the NATO countries without Eurofighters like Norway, Denmark, Netherlands and Belgium most likely needs it and the UK/Spain/Italy would want to trade in the expensive Eurofighters for F-15’s. Others having F-15’s and wanting F-35’s like Qatar and Saudi will evetually get them when the US gives high enough compensations to Israel like buying their missile systems…
Lots of “if” and “should” if you ask me.
Military is ok, but in civil aircrafts Boeing just got the lower end of the products.
A220 and A320neo are just better than any SA Boeing has, only the Max 8 can somewhat compete.
The B787 is a great airplane, but it’s basically the B789, has the overall issue cost wise and might be in trouble due to low demand for widebodies.
The B777x is subpar to the A350 which is giving the B787 a good run for the money. Which leaves the A330neo open, doing exactly what Airbus wants it to do: price pressure Boeings B787, and if it’s still true you can buy a B789 for 115 mio. $ than you may ask yourself how Boeing will ever regain its cost & investment.
The B767 is on the way out, but the KC 46 was one of those victories that can cost you the company. Everyone knows the A330 MRTT is the better plane, thus it did win twice.
I don’t like Boeings position at all, nor do I belive that this management can fix the underlying cultural causes of this situation.
On the commercial side the 737MAX8 should be much cheaper to produce and sell for almost the same price as the A320neo. I agree that the heavy 777 has problems with the A350 and the 787-10 too short range. So when the new generation widebody engines get onto the 787-10 and A350-1000 those 2 carbon aircrafts will dominate once pax load comes back up. Boeing copying the GE risk and revenus sharing setup with its suppliers can spread any losses among them and keep the majority of profits once times are good. Hence it could be that RR with the Ultrafans gives Boeing a big boost on the 787 and pulls it into the black.
It is always if’s and maybe’s when a company need to execute right, it can go wrong in so many ways and the skills of the company and its consultants are there to correct things that went wrong. Just ask PWA of the TF-30/JT9D/F100/JT-8D/PW2000/PW4000/PW1100G and derivatives early troubles and hard work to get it almost right.
Na, not really.
Neither the Ten nor the 1000 really kills it sales wise.
What do you think will the Ultrafan bring?
10%? You will not get the range out of the Ten and it has a direct competitor with a more suitable wing, the A359.
The market has settled around the A359 and B789.
Also, I don’t see Boeing and RR getting close after the desaster the Trent has caused at the B787.
“The deferred costs have been burning off since 2015.”
How much remains currently in the “deferred” basket ?
Being able to empty that basket was “away explained” with gains from a rather high production rate and high demand allowing pricing power.
About $18B, including tooling
https://www.boeing.com/investors/accounting-considerations.page
It doesn’t look like a big opportunity.
The MAX is a big damage but covid is a landslide.
Long ago a $18b loss for the MAX was reported. When was it, December? At that time the loss per month was more than $1b. Now it should be much more than $19b.
All the systems the MAX will need don’t seem to generate a profit. RTS doesn’t seem to be this year. I can imagine all the pre delivery payments are already burned, they needed a loan to pay a stupid divident. Boeing might need to pay more to suppliers for each MAX they assemble than the money they get.
Wait for Norwegian, they are asking for more than $1b alone.
Now airlines are asking for lease backs or they won’t take the planes.
They increased the safety on the MAX but that doesn’t mean it is safe. Another crash will happen. And then?
We can see the criminal wrong doings now live.
This has been the issue regarding program accounting from its inception. Simply it does not cope well with change as the accruals concept is seen to take precedence over prudence. All very well if things don’t change but given something adverse happening all variables tend to go south in tandem, order books fall, production slows, unit costs rise, prices are under pressure etc etc. This is why the accounts of Boeing are more susceptible to significant change. This is not a COVID thing but relates to any adverse change and Boeing has seen many recently. So the accounts, rather than smoothing profit flow will illustrate over optimistic return based on assumptions followed by severe write downs
Totally agree!
program accounting is not a good system.
existing US rules are incredibly lax and allow any behaviour .
very unsafe.
BOEING looked much too profitable these last years, and became complacent.
But it will be in a very Dangerous position in the coming quarters.
european rules give smoother évolutions of Bottom lines….
Roller coaster may be good for inspired shareholders, but it is definitely bad for labour, and product quality.
What a mess at Boeing; new heads are really needed!
It is such a pity to see that company slowly going down the drain.
excellent write up with good knowledge and excellent substance
Take it easy and let the music play on.
Actually there was already some kind of write-off related to the 787 program accounting. A few years ago, Boeing wrote-off as R&D some “early teens” that could not be sold. I think it was something like $1.2B for three aircraft.
@Jacques: You are correct, but this is different than a “forward loss.”
I understand, but my point is writing off some of those production cost as R&D help keeping the production block with a net positive value. It is not the same thing but playing that kind of “accounting game” by assigning important early production cost to those three unit as R&D (basically considering them as “prototype”) help preventing/delaying a reach forward situation. I am correct?
https://www.investopedia.com/terms/l/losscarryforward.asp
‘A loss carryforward refers to an accounting technique that applies the current year’s net operating loss (NOL) to future years’ net income to reduce tax liability.’
I hope thats the right one, as IRS has different rules for different situations
In essence that was effected by those early frames ( single digit SN ) no longer being movable to customers ( and thus part of the production cost basket ) as planned.
Oh well. Most of these losses will be “paper losses” so I don’t really see it as a “big deal”. In fact, Boeing stock is actually up today.
That being said, Boeing needs to get their strategy in order…pronto.
Sarcasm? Or extremely positive?
The “paper losses” and the stock being up were somewhat positive.
Getting their strategy in order…no sarcasm.
It seems to me that the Everettt facilites are paid kfor.
Curious what acualy costs are outstanding? Tools would be paid for as well. Did they borrow money for the programs?
Its not like they built anything at Everett, they just shuffled the build lines around within it.
767 and 747 should have paid that building off a long time ago.
Their only external costs are utilities and taxes. They pay no heat or cooling. So that leaves taxes, sewer and water and a lot less power than Charleston with its A/C).
Is that true? No heat or cooling? Seems unlikely in a WA winter to not need heating on the floor, let alone offices etc & maybe climate control (even if just humidity control) for some parts.
Anyway, add lighting, maintenance, human provisioning, ancillary employees, IT ongoings, on and on….., there are lots of costs to keeping a facility of that size ticking over even if the original fabric was fully paid off.
Yep, I took the tour.
Close the doors and the heat build up from all the lights and computers/people, coffee pots heats the building just fine.
Summer, they open the doors.
If memory serves me like 7 million a year in saved heating cost (no A/C as they just open the doors more)
Point is all that infrastructure is paid for many times over.
Maybe someone can answer on write doing on equipment under forward accounting insanity.
Drop 747 and the 767 and costs also go down as the stuff associated with that is no longer up and running (tooling moves to Charleston for backup or ramp up for their second line, Charleston is under utilized.
25% extra space has been added for 777X production, (200,000 sq ft) mostly the wing factory behind the main assembly building
I guess they can park their cars out of the rain in the empty sections.
From the beginning, the program accounting projections assumed steady or increasing production and optimistic productivity gains over the entire accounting block of 1100 or 1300 airplanes.
When in the history of this industry have we had rock-solid stability and steady growth for that long?
The idea of forward loss was not a question of “if,” but “when.”
The fundamental issue was that Boeing racked up $30 B in deferred productions costs at the beginning . Once they dug the hole that deep, it’s hard to imagine how things would go super-smooth for decades to recover that initial loss.
I think now that the accounting block is about 1700 units, not too unrealistic considered a total order books of about 1500 units.
And does that cover ROI?
How much interesting could I earn on 30 billion in a safe portfolio?
@TransWorld:
I agree and that was what my original argument >15 years ago was regarding the A380 (A3XX at the time).
Fortunately Airbus has done well since with the A32X and A350’s.
As a Boeing “Koolaider” but an Airbus stock holder, I have mixed-views on the whole situation.
I would like to see Boeing’s stock go down (back to the lows earlier) for me to pick up shares.
Funny at the time of much lower prices, I was going to do a major Boeing invest, but I wound up with a broker and mixed portfolio.
Knowing what I know now I would never have bought it and I would have made a killing. Go figure.
When you pick a stock that goes good for the wrong reasons you should not be investing (so I don’t!)
@TransWorld,
Fortunately my Airbus stock has done well. I think if Spirit Aerosystems can get through this COVID-19 situation, it will do well. I like the fact they get business from both Boeing and Airbus.
Disclaimer: I (currently) own Spirit Aerosystems as well.
It seems to me it is in Boeing interest to create a forward loss. They can then use that loss against profits on other programs helping with cash-flow. Sure the stock may take a hit but the past expenses are sunk and right now cash-flow is the most important thing.
I agree – cash is king right now. As I mentioned above, (almost) everything else (in terms of profits, losses, etc.) is just accounting gimmick. Taking losses right now would help Boeing down the line.
FAA fined Boeing
“”for $184,522, in response to an allegation that in February 2020 Boeing “failed to follow its quality control processes and subjected ODA members to undue pressure or interfered with an airworthiness inspection of a Boeing 787-9”. (FlightGlobal)””
Calhoun haha … nothing has changed, the monkeys are still beating,
but I must admit the fine was very cheap.
How is it called when someone loves to get a beating …
Emirates puts pressure on Boeing. Now that the 777X is delayed to 2022, Emirates questions if certification will be delayed further, same as it happened with the MAX. They say if business will recover in 2021 they want to compete with their ordered 777-9.
Since Boeing can’t guarantee 777-9 delivery it seems to me Emirates will cancel more 777X.
777-9 delivery was scheduled for 2020.
Could be that there will be vaccination available in 2021 which could boost long distance flying.