Thank you for standing by. Good day, everyone, and welcome to The Boeing Company's second quarter 2016 earnings conference call. Today's call is being recorded. The management discussion and slide presentation, plus the analyst and media question and answer sessions are being broadcast live over the internet. At this time, for opening remarks and introductions, I'm turning the call over to Mr. Troy Lahr, Vice President of Investor Relations for The Boeing Company. Mr. Lahr, please go ahead.
Thank you. Good morning. Welcome to Boeing's second quarter 2016 earnings call. I'm Troy Lahr, and with me today is Dennis Muilenburg, Boeing's Chairman, President, and Chief Executive Officer, and Greg Smith, Boeing's Chief Financial Officer. After management comments, we'll take your questions. In fairness to others on the call, we ask that you limit yourself to one question. We have provided detailed financial information in today's press release, and you can follow the broadcast and presentation through our website at boeing.com. Before we begin, I need to remind you that any projections and goals in our discussions today are likely to involve risk, which is detailed in our news release, various SEC filings, and the forward-looking statement disclaimer in the presentation. In addition, we refer you to our earnings release and presentation for disclosures and reconciliation of non-GAAP measures that we use when discussing our results and outlook.
I'll turn the call over to Dennis Muilenburg.
Thank you, Troy. Good morning. My comments today will focus on our second quarter results, the health of our business environment, and our growth plans going forward. After that, Greg will walk you through the details of our financial results and outlook. Let's move to slide two. Our second quarter financial results included both the continued solid underlying operating execution and strong cash flow performance of our commercial and defense businesses, and a substantial impact to earnings from decisions we made on the 787 and 747 programs, and increased investment needed on the KC-46 Tanker program. I'll come back to explain each of those items in a moment, but let me say up front that we're confident that the decisions we made on 787 cost reclassification and 747 production were the right proactive ones to reduce future financial risk and strengthen our position and focus going forward.
The added investment on Tanker, while not insignificant, enabled completion of important testing while sustaining our view of the long-term, multi-decade value this program will generate for our customers and our shareholders. Excluding those items, both of our businesses produced double-digit margins in the quarter, and we continued to deliver on our commitments to invest in innovation while also returning cash to shareholders. We generated $3.2 billion of operating cash flow in the quarter, repurchased $2 billion of Boeing stock, and increased our dividend per share 20% over the prior year, for a payout of $691 million in the quarter. Revenue in the second quarter increased to $24.8 billion on strong commercial airplane deliveries and growth in our services business.
We reported a core EPS loss of $0.44, reflecting continued solid operating performance across our production programs that partially offset the 787 cost reclassification and the 747 and Tanker charges. On the 787 program, during the quarter, we reached a decision point on whether to move forward and invest funds for the refurbishment and future sale of the two remaining initial flight test aircraft. We elected not to do so, and subsequently, we reclassified unit costs associated with those aircraft from program inventory to R&D expense, resulting in a non-cash $847 million after-tax earnings impact. On the 747 program, we decided to reduce future production expectations and revenue assumptions to account for current and anticipated weakness in the air cargo market. These program assumption changes drove the $814 million after-tax charge in the quarter.
These charges also include the write-down of the remaining 747 deferred production costs, which significantly de-risked the program going forward. Despite the ongoing challenges of the air cargo market, we continue to see the 747 as a unique and significant value creator for our customers over the long term. The $393 million after-tax charge on the KC-46 Tanker program reflects our assessment of the cost to address previously announced program schedule and technical challenges, including implementation of the hardware solution to resolve the refueling boom axial load issue identified during flight testing, delays in the certification process, and concurrency between late-stage development testing and initial production. To the credit of our team working with the Air Force, the hardware solution to the boom issue worked as planned.
With the aircraft's recent success in refueling an F-16, A-10, and C-17, we have now completed all required testing to receive the Milestone C production approval from our customer, which is expected next month. Recognizing the risks inherent in the remainder of the flight test program, our team is dually focused on the work ahead on meeting our commitments under the revised program schedule and providing our Air Force customer the best aerial refueling tanker ever built. While we are reducing core EPS guidance for 2016 to reflect the impact of these three items I just covered, we are maintaining our revenue and cash flow guidance based on the underlying strength of our business. Greg will provide more details on that later. Now, let's look at the second quarter operating performance for both of our businesses. At Boeing Commercial Airplanes, second quarter revenue increased 3% to $17.5 billion.
On 199 deliveries. Notwithstanding overall solid core operating performance, the charges and cost reclassification led to an operating earnings loss in the quarter. Key milestones in the quarter included successfully delivering the first 12 per month rate aircraft on the 787 program, declaring the 787-10 production ready, opening the 777X composite wing center, and completing high altitude flight testing on the 737 MAX, which continues to run ahead of schedule. At Boeing Defense, Space & Security, second quarter revenue was $7.2 billion. Operating margins were 8.3%, reflecting strong performance offset by a portion of the Tanker charge. Key contract awards during the quarter included an order for 12 CH-47 Chinooks for the Royal Netherlands Air Force and 24 AH-64 Apache helicopters for the Qatar Emiri Air Force.
In summary, notwithstanding the accounting charges and the cost reclassification in the quarter, we had solid underlying operating performance, achieved critical program milestones, and returned significant cash to our shareholders. With that, let's turn to the business environment on slide three. Our overall view of the business environment remains generally positive due to healthy industry fundamentals. We've recently updated our 20-year commercial market outlook, and based on solid traffic growth and continued replacement demand, we now forecast nearly $6 trillion of demand for 39,620 commercial airplanes, an increase of nearly 1,600 from last year. Global passenger traffic continues to solidly outpace GDP, with IATA reporting 6% growth year-to-date. On the cargo side, the market remains sluggish, with year-to-date freight traffic down approximately 1%.
We continue to keep a watchful eye on global market conditions for both passenger travel and cargo to ensure that supply and demand are balanced, with particular attention being paid to the wide-body segment. While oil prices have meaningfully rebounded from lows earlier this year, our customers continue to tell us that movements in oil prices have not substantially changed their view on future fleet planning or their commitment to existing delivery schedules. As always, we see isolated pockets of market softness, such as Russia and Brazil. We will continue to manage our skylines to maintain production schedules and health. New order activity is continuing at a moderate but healthy pace, as indicated by the flow of announcements at the Farnborough Air Show. As a result of the compelling and enduring value proposition of our airplanes, requests to change deliveries are holding well below the historical average.
Over the past 12 months, deferrals, accelerations, de-bookings, and cancellations remain at about 1% of our backlog. We continue to expect commercial aircraft deliveries to ramp up beyond 900 aircraft per year through the end of this decade, driven by ongoing market demand and our sizable and diverse backlog. Turning to individual airplane programs, demand remains strong for the 737, with a robust backlog of nearly 4,400 firm orders. We remain on track to raise 737 production from the current 42 per month to 47 in 2017, followed by 52 per month in 2018, and then 57 per month in 2019. Importantly, even at the 57 per month rate, we continue to be oversold. Turning to the twin-aisle market, while long-term demand remains strong, we have seen some hesitation in near-term demand in recent months, varying by program.
For the current generation 777, our backlog as of the end of the quarter stood at 175 airplanes. So far in 2016, we have added eight net new 777 orders and commitments. For the full year, we are targeting approximately 40 orders as we focus on ensuring a smooth, profitable transition to the 777X production. Our 777 delivery slots are completely sold out for 2016 and more than 80% sold out for 2017. For 2018, when we will begin phasing in production of the 777X test aircraft, we are nearly 60% sold out at the lower planned delivery rate of approximately 5.5 per month. We are working an active customer pipeline to fill the remaining 2017 and 2018 delivery slots. We clearly have more work to do over the next few months to hold the current 777 production plans.
With a strong foundation of 306 orders from six customers, interest and demand in our new 777X remains high, and the development of this next game-changing wide body remains on track. On the 787 program, our backlog of more than 700 orders remains the foundation behind our production rate plans. As we discussed at our investor conference, securing additional orders to solidify our end of the decade 14 per month production rate plan remains a priority. As always, aligning supply and demand to maximize profitability will guide our decisions on 777 and 787 production plans. On the 747 programs I mentioned earlier, air cargo market headwinds continue to pressure demand and pricing. So far this year, we have captured four 747-8 freighter orders and continue to work a number of sales campaigns to fill the 747 production skyline. That said, this segment of the market remains challenging.
We will continue to monitor it closely while aggressively driving productivity and cost reduction to win additional orders. Continue to deliver on our strategy to grow this element of our business. We recently announced agreements with six airlines from around the world to provide advanced analytics solutions to increase their efficiency in operating over 500 airplanes. Furthermore, in the largest commercial airplane services deal in Boeing history, Norwegian committed through 2034 to GoldCare coverage for both its 737 MAX fleet and to expanded coverage of the airline's entire 787 Dreamliner fleet. Our significant global scale and depth, intimate aircraft knowledge, and our substantial installed base combine to provide a meaningful opportunity to continue growing our services and support business, including our traditional parts, mods, and upgrade business, as well as expanding further into data analytics and information-based services.
Overall, the outlook for Boeing Commercial Airplanes remains positive as we continue to execute on our robust backlog, smoothly transition 737 production to the MAX, and complete development of the 777X and the 787-10. Turning to Defense, Space & Security, we continue to see solid demand for our major platforms. Domestically, the president's budget request for fiscal year 2017 advances key BDS programs. We are anticipating a period of modest growth in defense spending over the next five years. Internationally, demand for our offerings remains healthy as well, in particular for rotorcraft, commercial derivatives, fighters, satellites, and services. During the second quarter, international customers represented 29% of BDS revenue and 37% of the current backlog. The strength of our Defense and Space business stems from our solid portfolio of products and services, our investments in innovation and affordability, as well as leveraging our One Boeing advantage.
We continue to focus on areas that are priorities for our customers, such as commercial derivatives, rotorcraft, satellites, services, human space exploration, and autonomous systems. We are investing in future franchise programs and leveraging capabilities and technologies across the enterprise for the T-X trainer, JSTARS recapitalization, MQ-25A, formerly known as UCLASS, advanced weapons programs, and other important opportunities. We are also encouraged by the domestic and international opportunities for our proven, affordable, and highly capable fighter aircraft. In summary, our plans and strategies are aligned to the realities and opportunities of our markets. Our teams are focused on innovation and growth and on delivering solid operating performance. We remain confident about our position and future prospects. Our focus is on accelerating our efforts to drive quality, safety, productivity, and organizational improvements through the implementation of Lean, capturing the value of quality, Partnering for Success, and our second-century design and manufacturing initiatives.
Over to Greg for our financial results.
Thank you, Dennis, and good morning. Let's turn to slide four and we will discuss our second quarter results. Second quarter revenue increased to $24.8 billion, driven by strong commercial airplane deliveries and solid defense revenue. Core earnings per share was a loss of $0.44, impacted by the previously announced $3.23 of charges and cost reclassification. Notwithstanding these impacts, the core business performance was solid in the quarter. Let's now move to commercial airplanes on slide five. In the second quarter, our commercial airplane business reported revenue of $17.5 billion on 199 airplane deliveries. BCA operating margin in the quarter were impacted by the $2.8 billion related to the 787 cost reclassification and the 747 and Tanker charges. Results were also impacted by higher planned R&D spending as we ramp up on the 777X program. Excluding the charges and the cost reclassification, BCA operating margins were a solid 10.3%.
Commercial Airplanes captured $11 billion in net orders during the second quarter, and backlog remains very strong at $417 billion and nearly 5,700 aircraft, again, equating to seven years of production. 787 deferred production declined by $1 billion in the quarter, driven by the cost reclassification, bringing the balance at the end of the quarter to $27.7 billion. When normalizing for the cost reclassification, deferred was better than planned at an increase of just $33 million. As we previously discussed, recovering the 787 deferred production over the remainder of the decade will be a significant driver of cash flows. Our confidence in this recovery and the cash generation comes from the shifting of the delivery mix for more dash 9s and 10s, improved pricing over the remaining 900 aircraft, and supplier step-down pricing, as well as internal productivity.
We continue to make progress on the 787 program, including successfully transitioning to the 12-per-month rate, increasing deliveries of the 787-9, reducing production flow times and lowering unit cost while introducing the 787-10 into the production system. Let's turn to Defense, Space & Security results on slide six. Second quarter revenue at our defense business was $7.2 billion, and operating margins were 8.3%, largely driven by the strong performance that was offset by the BDS $219 million pre-tax Tanker charge. Boeing Military Aircraft second quarter revenue was $3 billion, reflecting lower planned C-17 and Chinook deliveries. Operating margins of 5.9% reflect the impact, again, of the Tanker charge. Network and Space Systems reported revenue of $1.8 billion, operating margins of 8.5%, reflecting the timing of ULA launches. Global Services & Support revenue increased 12% to $2.4 billion, reflecting higher volume in aircraft modernization and sustainment.
Operating margins were 11.1%, reflecting program mix. Defense, Space & Security reported a solid backlog of $55 billion with 37% of that business from customers outside of the United States. Let's move to the next slide, please. Operating cash flow of $3.2 billion for the second quarter was primarily driven by solid operating performance. With regards to capital deployment, as Dennis mentioned, we paid $691 million in dividends and repurchased 15 million shares for $2 billion in the second quarter, bringing our year-to-date repurchase to 44 million shares for a total of $5.5 billion, as we continue to deliver on our commitments to our shareholders. This reflects the ongoing confidence in our long-term outlook of our markets and our business. We continue to anticipate completing the remaining $8.5 billion repurchase authorization over the approximately next two years.
Returning cash to shareholders, along with continued investment to support future growth, remains top priority for us. Let's move now to cash and debt balances on Slide eight. We ended the quarter with $9.3 billion of cash in marketable securities. Our cash balance continues to provide solid liquidity and positions us well going forward. Let's now turn to Slide nine, and we'll discuss our outlook for 2016. We are reaffirming our 2016 guidance for revenue, deliveries, and cash flow. Our core EPS guidance for 2016 is lowered by $2.05 a share to now be between $6.10 and $6.30, reflecting the second quarter charges and cost reclassification totaling $3.23, that was more than offset by improved core operating performance and tax benefits.
The core operating engine continues to deliver strong results as we remain focused on increasing production, driving productivity improvements, maximizing cash generation, and efficient deployment, at the same time, taking appropriate actions to de-risk our business going forward. With that, I'll turn it back over to Dennis for some closing comments.
Thank you, Greg. As we move into the second half of 2016 and begin Boeing's second century in operation, we know we cannot stand still if we are to further our industry leadership and honor the rich legacy of generations of talented, hardworking people that built this company. Our teams remain intensely focused on growth, disciplined execution, quality and productivity improvement, and meeting our customer commitments. Our priorities are to continue building strength on strength, to deliver on our existing plans, and to stretch beyond those plans by sharpening and accelerating our pace of progress on key enterprise growth and productivity efforts.
Achieving these objectives will require a clear and consistent attention to the profitable ramp-up in commercial airplane production, continuing to strengthen our defense and space business, delivering on our development programs, driving world-class levels of productivity and performance throughout the enterprise to fund our investments in innovation and growth, and to develop and maintain the best team and talent in the industry. All of which is to position Boeing for the next 100 years in continued market leadership, sustained top and bottom-line growth, and to create increasing value for our customers, our shareholders, our employees, and other stakeholders. With that, we'd be happy to take your questions.
Ladies and gentlemen, to ask a question on today's conference, press the star key followed by the digit 1 on your touch-tone telephone. Again, it is star 1 for questions. In order that your question be clearly heard, we ask that you not use a speakerphone, cell phone, or phone headset. Please use your handset to ask a question. If you're on a speakerphone, please be sure your mute function is switched off so your signal can reach our equipment. Star 1 for questions. As a reminder, in the interest of time, we are asking that you limit yourself to 1 single part question. Again, star 1 for questions. First, we'll go to Cai von Rumohr with Cowen and Company. Please go ahead.
Yes, thank you very much. If you back the charges out of your BCA results, they look particularly strong. You did better on 787 deferreds. Could you comment on any profit accrual rate changes you had, any block changes you had in the quarter? How should we think about those opportunities and the deferreds on the 87 going forward?
Yeah, Cai, on 737, we did have a block extension there, we had an increase in overall booking rate on the program. Also on 767, we had a block extension there. We had a little bit better spending with regards to G&A and some other period expense, in particular, fleet support. Those were really the primary drivers in the quarter. Just good, solid performance across the programs. On the deferred, I'd say the profile of the deferred remains intact of what we talked about. Again, as we focus on unit cost, day-by-day, airplane-by-airplane improvement and getting that model mix up with more Dash 9s and now the introduction of the Dash 10, it's all about cash. How are we improving the overall cash flow of that program? Teams are doing a great job.
We got certainly lots of work in front of us, I think when you're out in the factories today, you'll see some very good momentum and very good focus on overall productivity initiatives that are also obviously going to help that cash profile going forward. The fundamentals as far as the cash flow story on 787 remain intact.
Thank you.
You're welcome.
Our next question's from Jason Gursky with Citi. Please go ahead.
Yeah, good morning, everyone.
Morning.
Hey, Jason.
Hey, Greg. I think this one will be for you. Wanted to talk a little bit about working capital.
Yeah
and tie that to cash.
Yep.
Been a lot of chatter out there, in the media, even amongst some of your suppliers that have hosted earnings calls-
this quarter, about a lengthening payable cycle at Boeing. I was wondering if you could just chat a little bit about your strategy there, how long it's been in place, how much more we have to go, and tie that to the sustainability of cash flows. Are we getting a one-time bump this year? Have you been working on this for a while, and it's been masked? I just want to get a sense of whether we're going to have some lumpy cash flow outcomes here over the next several quarters or the next several years because of the deployment of your new strategy here.
Yeah. Jason, I'd say this is just back to fundamentals around working capital. How we're collecting, how we're paying, ultimately how we're managing our inventory, and we've got initiatives in place for each. When it comes to payables, we have changed our frequency of pay that we've gone from daily to twice a month. Again, that's in line with industry practices. At the same time, we're looking at terms across all of our contracts, again, looking to get those to industry standards. Ultimately, we want to get those to top quartile standards, there's no reason why we shouldn't, frankly, a lot of our supply chain is already there. Finally, on the inventory, we're looking at all aspects of the inventory across the programs. Flow time on 787 is a great example of that, and we're going to continue that focus.
I wouldn't view it as anything special or different. Is there enhanced focus on those elements of cash flow? There certainly is, but that's the objective. Certainly get to industry standards, then beyond that, as Dennis has talked about, what does top quartile or a global industrial champion look like? There's no reason why we shouldn't be able to get to those levels of efficiency.
Jason, to the second part of your question there, as Greg has pointed out, this is not a one-time event or implementation.
Yeah.
We see this as a key element of our longer-term cash growth plan and consistent with our plans for the business to grow cash year-over-year.
Great. That's helpful. Thank you, guys.
You're welcome.
Our next question's from Seth Seifman with JP Morgan. Please go ahead.
Thanks very much, and good morning.
Good morning.
Thanks. Dennis, you mentioned services on the monologue. It also was a little bit more prominent in the release than it's been in the past. I wonder if at some point maybe you consider disclosing the services contribution at Boeing Commercial. Just as a question, we talk about services, but I think it really means kind of aftermarket more broadly, and that includes spares and parts. What part does that play in the strategy, and is there investment required there to either qualify new parts yourself or to incentivize the alternative suppliers to qualify new parts? Is that going to be meaningful at some point, and would it have only an impact on sort of new platforms going forward, or could it have an impact on existing in-production platforms?
Yeah. Great question, Seth. What you're pointing out here is, as we discussed at our investor conference, we see services growth broadly as one of our strongest growth areas going forward. That spans both commercial and Defense. It is a place where we are investing for the future, have been all along, you're beginning to see the fruits of that investment, we're going to continue to work on that front. That includes modifying our approach to our intellectual property and how we manage and control that, our proprietary parts business and what I'll call the traditional parts and modifications businesses that leverage our OEM knowledge base. It also includes a more significant investment in data analytics and information-based services. You can see some of the progress on that front. I mentioned a couple in my opening comments.
More broadly, we now have, for example, 60 airlines enrolled in subscription contracts for Boeing maintenance and engineering work. It covers about 2,200 aircraft. We have another 84 customers with about 3,800 aircraft that are benefiting from our airplane health management services. We still see a lot of runway ahead of us in these data analytics and information-based services agreements where we can add value for customers and also add value for Boeing. This includes an increased focus from our senior executive team on growing services, investments both inside of Boeing and with our supply chain, as you pointed out, we do see this as a long-term growth area, both top line and bottom line. In general, services is accretive to our margins and our bottom-line performance.
Great. Thank you very much.
Our next question's from Rajeev Lalwani with Morgan Stanley. Please go ahead.
Hi, gentlemen. Thanks for the time. As it relates to the 777, can you just talk about your comfort from here as it relates to getting the additional 40 orders that you mentioned, as well as the point at which you'll know whether or not the production cuts going into next year are sufficient?
Yeah, Rajeev, let me just take that one head-on here. On 777, we understand the reality of where we're at. As I said, in 2017, we've already announced we're going to a seven per month production rate. We're 80% sold out against that production rate. In 2018, as we introduce the 777X into the line, we build test aircraft. As we've announced before, the effective delivery rate in 2018 will drop to five and a half a month, and we're 60% sold out against that profile. We know exactly where we're at today. Now, the fact is, year to date, we've got net orders for eight 777s, against a target of approximately 40. Clearly we have work to do yet over the next few months to fill out that orders book. We're working hard on a number of key campaigns.
Ray and his team are out with our customers, we are aggressively working that every day. We do see that the value proposition of the airplane is holding up, the wide body market is clearly a challenging place right now. We've got work to do to find those additional orders. Now, in the case of if those orders don't materialize, we're going to continue to keep a close eye on our production plans and make sure that we keep supply and demand in balance. That's the key to our future, we're going to make sure we make a profitable and efficient transition to the 777X. We're going to continue to work those campaigns hard. We're going to work to fill out the production plans as we currently have laid them out, while being mindful of keeping supply and demand in balance.
all of this, I think it's important to take a step back from all of this to look at our overall plans over the next 5 years, regardless of how that scenario plays out on 777. This is a growing business where we're going to be delivering north of 900 airplanes a year by the end of the decade, and we see this as a year-over-year cash growth business spanning all of those scenarios that we're talking about. We're going to do the right thing here, keep wide body supply and demand in balance, make sure we have the right transition to 777X. I think it's also worth reminding that in the long term, the wide body marketplace is still an attractive marketplace. As you get out into the 2020s, there's a large replacement cycle that's very clear to us.
This is about efficient transition to the 777X, the 777X is the right airplane for the future, all within the context of a compelling growth story and year-over-year cash growth.
Thanks, Dennis.
Our next question is from Rob Spingarn with Credit Suisse. Please go ahead.
Good morning.
Morning.
Going back to the investor day, you talked about BCA margins improving double digit, I think, next year and mid-teens toward the end of the decade, if I have that right. Obviously, you have a lot of initiatives ongoing to get there. Wanted to ask you, how much of this margin improvement is negotiated or in place at this point, and how sensitive are those targets to any downside in 777, essentially relative to what you just talked about, Dennis?
Yeah. Rob, let me just paint the broad brush on that, and I'll ask Greg to tag team on this one.
Yeah.
Our plans for the future remain consistent with what you described, and that is we're headed towards double-digit margin in our commercial airplane business next year. Pleased with the performance this past quarter, but we know we still have work to do to make that sustainable. Then in the longer term, towards the end of the decade, headed towards that mid-teen margin aspiration. That's a tough, challenging target, but I think the right one for this business for the long term, and it will drive the right behaviors and investments for the future. Achieving those kind of margins spans all of our internal and external work. It includes our internal productivity work, the relentless focus on capturing value of quality, and our Lean+ efforts.
It includes our development program excellence initiative, all of the things we're doing to drive internal productivity to incrementally pick up margins. Things like block extensions on our programs are accretive to margins in general as well. As I mentioned earlier, as we grow the services business, that also tends to be accretive to margins. In parallel with that internal work, we're also working with our supply chain. Partnering for Success is a key element of this. While we've made a lot of advancements on that front, we still have a lot of work to do across our supply chain, and we'll continue to be relentless there as well. Think of this as a portfolio of effort all headed in the same direction.
Dennis-
Greg, you want to add anything to that?
Dennis, if I could just interject for a second just to clarify. Could you clarify or quantify the internal versus the external or the supply chain versus the internal in terms of the margins themselves, the upside?
Yeah. Rob, frankly, we're looking at market-based certainly across the board. Whether that's internal or external, it's all about market-based and really kind of backing into that. As you know, the greatest certainly percentage of our cost structure is outside, so we're equally focused there. At the same time, you've been in the factory recently during the investor conference, you can see there's a relentless focus inside. I'd say no rock unturned. We're looking for all opportunities, but just think about it as being market-based type targets that are driven through all the elements of the cost structure, whether it's in home office here or out on the programs. I think, as Dennis said, each of these are at different levels of maturity.
Some of these, obviously, we've captured some in certain aspects of the business, but I'd say everybody's very aligned on all the elements that Dennis talked about, this portfolio approach. I'd say it's all on our scorecards and being held accountable to try to achieve the aspirational targets that have been put out here.
This is a clear and enduring focus for us. It's about competing and winning in the marketplace. It's about returning value to our shareholders, and it's also about funding our future investments and our innovation. We intend to accomplish all three objectives.
The 777 sensitivity for this process?
Yeah. Well, as Dennis said, we've run, certainly, sensitivity analysis against the 777 bridge over that, I'll say, short period of time between the current platform and the X, and we've taken that into consideration around our comments about cash flow continuing to grow through that period. We think we can do that through that period, but we got a bunch of different scenarios, obviously, we're running through there. We're sticking with the plan we have and staying focused on trying to fill that bridge, in particular near term, but we got work to do. Like Dennis said, we'll match demand to production at the right time. It's one element of the portfolio, and I don't want anybody to over-rotate on that element.
It's an important one, there's a lot of other things going on in this company that are either driving profitability or cash, it's not just relying on one program having a transition rate for 18-24 months.
We're going to do the right thing to make sure we have an efficient transition to 777X, all of that is enveloped by an expectation of year-over-year cash growth. That spans all of the scenarios we've looked at.
Thank you both.
You're welcome.
Next, we go to Doug Harned with Bernstein. Please go ahead.
Thank you. Good morning.
Good morning.
Morning, Doug.
I'd like to see if we can understand a little bit more on the ramp down in deferred production for the 787, and there are really three aspects of it I'm interested in. One is, first, if you end up not going to 14 a month and staying at 12-
as a rate, what impact would that potentially have?
Yep.
Second, if on the 787, you've talked about the advantage on the Dash 9, you've got better pricing, and that the costs ultimately can come down to be comparable to the Dash 8. What timeframe would we expect to see those Dash 9 costs become similar on a unit basis to the Dash 8?
Yeah.
The third one of these is, on the 787-10, what kind of disruption would we expect given the high degree of commonality between the Dash 9 and the Dash 10 when it goes into service? Sorry, it's three parts, but all related to deferred.
I think I got them all, Doug. If not, I'm sure you'll tell me. First one, obviously we're not at the point of making any different rate decisions or assumptions than what we got in place, but as Dennis said, we got work to do to fill out to the 14. As you know, that's an end of the decade implementation. If you were to assume holding 12, it pushes that deferred curve out about six months. Not a significant impact. When you look at Dash Eight and Dash Nine, you saw it when you were out here. I'd say, the design improvements that were taken off the Eight and put onto the Nine, now that we're, I'll say, ramping up at, we're right about 10 a month right now on the Dash Nine, we are really seeing those come together in the factory.
Unit cost now is about in line on Dash Nine versus Dash Eight. The team, again, has done a great job. Lots of work in front of us, but the fact is over 125 units, and they're now at the same level as Dash Eight, I think gives you a good sense of the design for manufacturing implementation that's taken place on that airplane. Listen, there's still a lot of ideas in the hopper. Some of those will mature, some of them won't, but they're not slowing down, and Mark Jenks and his team are doing a terrific job looking for more opportunities. Disruption from Nine to 10, I think you said it is not as big of an impact, certainly as it is from the Eight to the Nine. That was by design.
That's in the production system today, we certainly have provisioned for some longer flow times on those initial Dash 10 units. Similar, I'll say, methodology that we did from the Eight to the Nine, we're again, I think as far as producing that airplane and a risk associated with that, it's a very different risk profile than it was from the Eight to the Nine. Again, take credit to the team on really focus on commonality in the production system to minimize that disruption as we enter it into the production system.
It's real manufacturing commonality that's north of 95%.
Yeah.
Doug, as you know, we've already begun major assembly work into the 787 line on the Dash 10. That manufacturing commonality is holding up as we're going through implementation.
Just if I can, on the rate change, the 12 to 14, what is the lead time that you need to pull the trigger to decide you're going up to 14 at a certain date?
Let me give you a little bit of a feel for that. Right now, we're sold out through 2018, if you look at the skyline on 787. We have a few open positions in 2019 that we're working, and we're largely focused on filling out the 2020 production skyline. That'll give you a feel for the timeframe that we're looking at. As Greg said, this is a toward-the-end-of-the-decade implementation, so you can back off from that a couple of years. We haven't pinned down a specific decision point yet because we're going to keep a close eye on the market, the signals from our customers. We've got time to do our due diligence here, and again, our principle here is to keep wide-body supply and demand in balance.
We're confident in the 787 program across that span of scenarios, and we're going to continue to work campaigns to fill out to the 14 a month rate step-up, and we'll evaluate timelines and decisions around that. You can be very confident that whatever we decide, we're going to keep supply and demand in balance. We're going to do it efficiently and productively. All of this, again, is enveloped by our expectation of a year-over-year cash growth business. It spans all of the scenarios we've talked about on both 777 and 787.
Okay, great. Thank you.
You're welcome.
Our next question is from Ron Epstein with Bank of America Merrill Lynch. Please go ahead.
Hey. Good morning, guys.
Good morning.
I guess maybe a question for both of you, just to see if we're thinking about this right. Does the roughly $1 billion of deferred that was moved pre-tax to R&D, does that imply, if you take that $1 billion, divide it by what's left in the block, that the profitability per airplane goes up by about $1 million on a program basis? I guess the second part of that question is, when do you expect the program on a unit basis to be cash flow breakeven for 787?
Well, we broke even late last year.
Okay, on a unit basis.
Obviously, as we move forward with the supplier contractual step-down pricing, the improved productivity, but even more, as I mentioned at the investor conference, Ron, the mix is a big play in here going forward. Getting these dash 9s into the production that we have, and you heard me talk about the unit costs recently and where they are getting that dash 10 in, are obviously big drivers of cash flow going forward. The program margin did go up slightly in the quarter overall, but it's still very low single digit.
Just curious, Greg, is it about $1 million per plane? Are we thinking about it right? Is it essentially $1 billion divided by 900, what's left in the block?
Yeah, I'm not really completely following your math there, Ron, I would just tell you that we took $1 billion out, obviously, and put it into R&D. Obviously, research and development went up, and the overall program margin went up slightly as a result of that move. Again, these are obviously two aircraft that we've been heavily utilized in flight test, and we made the right decision because it was the time to start spending company funds to modify those airplanes and a limited marketplace for them. We made that decision and reclassed them, and it was absolutely the right thing to do.
Okay, cool. Thank you so much.
You're welcome.
Our next question is from Carter Copeland with Barclays. Please go ahead.
Hey, good morning, gentlemen.
Hey, Carter.
Just a clarification on that last answer, Greg, then a quick question, you said unit breakeven last year. Do you mean cash breakeven on the program last year?
Yeah, on the program. Yeah.
Okay, we're close to eclipsing deferred production flipping over. That's obviously at one end of the line. When you've got stuff coming off the line is when you'd get to see unit versus program. When should we expect that to flow from the deferred production all the way out to where we see it in the cash and unit?
Later this year.
Later this year.
Yeah.
Okay. I wanted to ask about the 737 margin increase that you referenced associated with the block extension.
Yeah.
I know you had taken a rate adjustment downward associated with escalation in the past.
Yeah.
Is this a reversal of that, and have you recaptured that downward amount that you had before with this?
Yeah. There actually was still escalation pressure in the quarter across all the programs. Not as much as prior quarters, but there was. The balance of that was offset by improved productivity and mix. Those are really the big drivers in there, Carter.
Just volume in there. Okay.
Yeah.
With respect to escalation, I know it operates with a lag.
Yeah
You've seen the oil price come back up. That has a positive impact on that index. When does that make its way through the lag of the escalation formula?
I'm hoping very soon. Again, we saw it minimize this quarter, and we'll have to wait till the publications come out for third quarter. You're right, the fundamentals are heading in the right direction, so we should start to see this as a bit of more of a tailwind versus a headwind.
Great. Thank you, gentlemen.
You're welcome.
We'll go to Howard Rubel with Jefferies. Please go ahead.
Thank you very much. It's a two-part question related to some of the things you're doing internally. Greg or Dennis, you indicated the MAX EIS
Had accelerated so that, I think Norwegian even used a May date, which is pretty notable. Could you just address two things? One is, what are you doing with the benefit of this acceleration and improved process, how much of it's being used to either accelerate deliveries or do other things with the MAX? Also you commented on G&A being better, and I suspect it's probably due to, I'll call it the 787 performance, hitting some of the standards that you've aspired to. Could you, maybe put it together in an answer that sort of talks about some of the other things you're doing to, outside of just production, to make The Boeing Company and its customers better?
You bet. Howard, I'll take the first part and then ask Greg to take the second part. On the MAX, as you've noted, we have the opportunity to accelerate EIS. We had originally planned third quarter at 2017, we now have, publicly talked about that as first half of 2017. I won't be specific to individual customers as we have a number of discussions ongoing, but we have opportunities to accelerate into the first half of the year. What you should read through that is that the MAX development program is going very well and running on cost and ahead of schedule. We've got all four test aircraft in the air, more than 300 hours on the airplanes, the performance is looking solid, and the development program is clean.
More broadly, to get to your underlying question, I think this is a good example of how we can and should perform, coming out of our Development Program Excellence Initiative. This is about understanding the statement of work clearly upfront, managing that statement of work, keeping it balanced, doing the right systems engineering work, working with our supply chain. This is about disciplined innovation, we're going to bring a product to the marketplace that has a great value add for our customers and do it in a way that's disciplined and on cost and schedule. That formula that we've put in place now with our Development Program Excellence Initiative, we know it works, and we're taking the lessons learned from MAX, and we're cross-deploying those now into programs like the 787-10, the 777X, and into our future defense development programs.
Our objective here is very clear, and that is to have disciplined, effective development programs that perform on cost and schedule that allows us to do reliable R&D planning and allows us to make the best use of our innovation investments. It's a good signpost for us, Howard. I think, clearly a step in the right direction, and we're going to leverage lessons learned from 737 MAX across the whole enterprise. Greg, you want to hit the second part?
Yeah. Howard, I guess, with regards to the non-production, it's the same approach. We're really kind of trying to look at just even functional costs, across the enterprise and looking at what is market-based affordability, what's best in class look like for an industrial company, and challenging ourselves in where we are versus where they are, and trying to learn for some best practices and then trying to implement them. Now, some of this is still in the planning stage. Certainly not all of it is implemented, so I wouldn't run with any of it. That's the framework, and that's the operating around it. It's all about, how do we compete in the marketplace no matter what marketplace we're in across the portfolio. How do we generate cash in order to invest in our future as we have, and then deliver value to the shareholders.
Those are kind of the, I'll say, the framework that's around the approach. Again, it goes back to my comment about no rock left unturned. Whether it's functional costs that are supporting a program or program specific, everybody has an affordability target. Again, different levels of maturity. Some are making more progress than others, but the focus and the operating rhythm is all around that.
I just want to make sure I understand then that, is some of this that you saw in this most recent quarter going to translate into either permanently lower G&A or also, a little bit better R&D profile for the back half of the year?
Yeah, I think the R&D profile will be similar to what we outlined. I don't see that changing. On the G&A, quarter-over-quarter, as you know, you're going to see it move around a little bit, but some of that certainly is sustainable and some of that is just timing.
Thank you.
You're welcome.
Operator, we have time for one more analyst question.
That'll be from Sam Pearlstein with Wells Fargo. Please go ahead.
Good morning.
Morning.
I guess, really, Greg, I was going to ask you just, we've seen a lot in terms of the interest rate move this year, and I know you don't include pension in the core earnings, but can you just talk about required contributions or how to think about pension contributions over the next several years and how that may be changing in terms of, with lower interest rates?
Yeah. No, certainly something, Sam, we're watching. Obviously, with the transition that we made from the defined benefit, defined contribution, that certainly helps us going forward when it comes to pension contributions. We're certainly monitoring the interest rate environment. This year is obviously minimal. As I see it today, there'll be contributions required next year. They'll be again in the $ hundreds of millions, not more than that. Kind of see that in the year following, but again, we'll have to see where interest rates fall.
We'll make the required contribution. We run that at kind of various levels. Again, because of the pension turnover, I don't see, obviously, that kind of headwind that I would've normally seen as far as required contribution if we were stuck with a DB plan for the next five years.
Great. Thank you.
You're welcome.
Ladies and gentlemen, that completes the analyst question and answer session. For members of the media, if you have a question, please press the star key followed by the digit 1 on your touch-tone phone. I will now return you to The Boeing Company for introductory remarks by Mr. Tom Downey, Senior Vice President of Corporate Communications. Mr. Downey, please go ahead.
Thank you. We will continue with the questions for Dennis and Greg now. If you have any questions following this part of the session, please call our media relations team at 312-544-2002. Operator, we're ready for the first question, in the interest of time, we ask that you limit everyone to just one question, please.
We'll go to Julie Johnsson with Bloomberg. Please go ahead.
Hi, everybody. Good morning.
Good morning, Julie.
Dennis, a quick question. Could you just step back and sort of spell out your expectations for 747 following this latest reset? Do you see a future for this program beyond Air Force One?
Yeah, Julie, as we announced, the decision we made here takes into consideration a sluggish cargo market and our projections for future production rates. The decision, in essence, that we made was to maintain our current production rate of half an airplane per month that we're implementing this year, and to extend that out into the future, rather than assuming we would ramp back up to one a month in 2019. That's the fundamental assumption change here. It reflects what we see in the cargo market. Now, we still see a cargo or freighter aircraft replacement cycle out in that 2019, 2020 timeframe. We have a number of ongoing customer discussions in the cargo marketplace in addition to the two Air Force One airplanes that you referenced. A number of very viable campaigns underway to fill to that half-a-month production rate.
That said, we still have our work cut out for us. Cargo is a tough market right now. I will say that the decisions we've made on 747 put that program in a much more solid footing for the future. It's aligned with the marketplace. As noted, we also wrote off any remaining deferred production inventory. We've significantly de-risked that program from a financial standpoint for the future. We're going to continue to work to fill out the skyline.
Our next question's from Jon Ostrower with The Wall Street Journal. Please go ahead.
Hey, good morning, guys.
Morning.
Hey, Jon.
A question about this change in supplier payment frequency. You talked about the need to be more competitive, align with how your suppliers are paying their own suppliers. Ultimately, what is the goal here? What are you trying to be more competitive on? You've riled up GKN and Rockwell Collins, two of your closest suppliers that have, Rockwell Collins most notably, has been held up as your sort of greatest example of how you want to be Partnering for Success as part of your cost cutting. Now they're out there really upset that they're missing their bottom-line targets in the quarter. I just want to understand what exactly you're trying to accomplish by doing this, beyond just an industry norm practice when you've got your closest suppliers, who very rarely air public grievances, calling you guys out.
Well, Jon, I guess I would start with, obviously, we're in a competitive environment. It all starts with market-based affordability. Then how does that impact your business when we, as I indicated, when it comes to working capital, we're looking at where we are on different measures around working capital and where everybody else is in this industry. Certainly, the two suppliers you called out are great suppliers to us. We've been working with them over the last year on transitioning to a more, I'll say, industry standard around payments. We were paying daily, millions of transactions. We were paying daily. That's not an industry standard. We're going to twice a month.
We're looking at terms, again, to be competitive, manage our working capital efficiently, allowing us to invest in our future that ultimately everybody will benefit from our customers down to our suppliers. These are important partners. Hey, we got to face into the environment that we're in and be efficient across the board. As you know, under Partnering for Success, this is also us reaching back in the supply chain, taking best practices that we have encountered in other parts of our business or the supply chain, and sharing those with the supply chain to ultimately make them better. I'd say it's across the board, and again, it's all about being market based and facing into those realities and, frankly, in this case, just getting to industry standards.
Our next question's from Alwyn Scott with Reuters. Please go ahead.
Hi, good morning. Dennis, you mentioned slowing wide-body sales and keeping an eye on rates to maintain balance, and it seems like there's a bit more emphasis there on that rate adjustment possibility. Given your pledge really not to cut prices to win orders, is the 1-to-1 book-to-bill ratio now really an aspirational goal? If not, what are you doing to improve sales?
Yeah. Hey, Al, first of all, more broadly, we're still targeting a book-to-bill of 1-to-1 for the year. Again, we don't get too encumbered with the exact timing of those orders, and it's very clear that this year's order cycle is more favorable on the narrow-bodies. If you're looking at numbers of aircraft, we expect the predominance of that orders flow this year to be in the narrow-bodies arena. That all said, we're going to continue to work hard to fill out the wide-body skylines as well. We don't need to make drastic changes to pricing in order to capture market share. We're not going to be driven to just get market share for market share's sake. I will say in the wide-body marketplace, even though we're seeing some hesitation in buying, the value proposition of our airplanes is holding up well.
This is all about a look ahead to efficiently managing our production skyline and keeping supply and demand in balance. Clearly, we've got more work to do on the widebody front, while narrowbody orders are trending to be very healthy and continuing to be healthy this year. That's our headset. As normal, we do a lot of scenario planning around this and different assumptions around widebody orders and what that future skyline will look like. As you heard earlier, our commitment is to make the decisions that allow us to make the transition on the 777 efficient and productive, and we will do that.
Operator, we have time for one last question, if there is anyone remaining in the queue. We'll go to Benjamin Zhang with Business Insider. Please go ahead.
Good morning, gentlemen.
Morning.
Morning.
I just wanted to take a step back and talk about the 787 program. I was wondering if you guys could give us an update on the remaining Terrible Teens inventory of the early build aircraft. How many do you guys have left, and what are your plans for them?
Yeah, they're all sold, they'll deliver here over the next couple of years.
That concludes our earnings call. Again, for members of the media, if you have further questions, please call our media relations team at 312-544-2002. Thank you.