The Boeing Company (BA) Q2 2013 Earnings Conference Call July 24, 2013 10:30 AM ET
Troy Lahr – Vice-President, Investor Relations
Thomas J. Downey – Senior Vice President, Communications
W. James McNerney, Jr. – Chairman, President and Chief Executive Officer
Greg Smith – Executive Vice President and Chief Financial Officer
Joseph Nadol III – JPMorgan
Douglas Harned – Sanford Bernstein
Robert Spingarn – Credit Suisse
Cai von Rumohr – Cowen & Company
Sam Pearlstein – Wells Fargo
Carter Copeland – Barclays Capital
Howard Rubel – Jefferies
Robert Stallard – Royal Bank of Canada
Ronald Epstein – Bank of America Merrill Lynch
John Godyn – Morgan Stanley
Noah Poponak – Goldman Sachs
Jason Gursky – Citigroup
Jon Ostrower – Wall Street Journal
Julie Johnsson – Bloomberg News
Dominic Gates – The Seattle Times
Joshua Freed – Associated Press
Andrew Parker – Financial Times
Veronique Dupont – Agence France-Presse
lwyn Scott – Reuters
Thank you for standing by. Good day everyone and welcome to the Boeing Company’s Second Quarter 2013 Earnings Conference Call. Today’s call is being recorded. The management discussion and slide presentation plus the analysts and media question-and-answer sessions are being broadcast live over the Internet.
At this time for opening remarks and introduction, 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 and good morning. Welcome to Boeing’s second quarter 2013 earnings call. I am Troy Lahr and with me today are Jim McNerney, Boeing's Chairman, President, and Chief Executive Officer; and Greg Smith, Boeing's Chief Financial Officer. After comments by Jim and Greg, we'll take your questions. In fairness to others on the call, we ask that you please limit yourself to one question. As always, we’ve provided detailed financial information in our press release issued earlier today.
As a remainder, you can follow today’s broadcast and slide presentation through our website at boeing.com. Before we begin, I need to remind you that any projections and goals we included in our discussion this morning are likely to involve risks, which is detailed in our news release and our various SEC filings, and in the forward-looking statement disclaimer at the end of the web 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.
Now I’ll turn the call over to Jim McNerney.
W. James McNerney, Jr.
Thank you, Troy and good morning everybody. Let me begin today with the quick update on the ongoing analysis of the 787 incident at Heathrow, earlier this month, followed by an overview of our business environment with some thoughts and another strong quarter of operating performance. After that Greg will walk you through our financial results and outlook.
As all of you know, the safety of our passengers and crew members who fly on Boeing airplanes is our highest priority. While we are limited in what we can say publicly by the rules of the investigation, we are working closely with the UK Air Accidents Investigation Branch or AAIB, and other parties to fully understand the incident, and to address recommendations in the AAIB’s Interim Report regarding the fixed Emergency Locator Transmitter or ELT, a component which is widely used across the industry and has been for number of years on many different aircraft types.
In anticipation of planned action by the FAA and other regulators in response to the AAIB’s recommendations, we have provided customers instructions for the proper inspection and/or temporary removal of the fixed ELT’s. While the AAIB’s interim report also noted that the history of this unit across the global airplane fleet suggest that an event of this sort would be extremely rare, we agree that these are reasonable precautionary measures to take while the investigation continues, in sum we believe good progress has been made in addressing this issue and we remain highly confident in the future of the 787 program and the integrity, safety and performance of the airplane.
With that let’s turn to the business environment on Slide 2. Global customer demand remains strong for our fuel efficient and value creating commercial airplane family and that is evident in the continued vigorous order activity we are seeing. During the second quarter, we booked 481 net orders, which increased our record commercial airplane backlog to nearly 4,800 airplanes worth $339 billion.
Our customers continue to replace older airplanes in favor of new ones that offer compelling economics and increased fuel efficiency. Deferral requests remain well below the historical average and request to accelerate deliveries continue at a healthy pace. We continue to see relatively balanced demand geographically and our backlog remains evenly split between airplanes used to support traffic growth and fleet replacement.
Passenger traffic trends are healthy and have grown even stronger in the past few months. While we continue to see near-term pressure in the cargo market, we are pleased with the recent 774 freighter ordered activity, highlighting the superior value proposition of our airplane and its competitive position in the market.
Strong customer interest in our future new airplanes has fully affirmed our product strategy, and the market leading position it has earned us. Our airplane family has produced – provide the most comprehensive value in the market for the product strategy that is customer driven, customer focused and customer generated and touches every market segment.
Last month, we launched the 787-10 with 102 orders and commitments, including 50 firm orders from five of the most prominent customers in the industry. The -10 further strengthens our unmatched twin-isle lineup and leverages prior technology investments. It is a win-win approach that allows us to provide our customers an airplane with unparalleled economics, while minimizing business risks to deliver increased shareholder value.
The business case for the 777-X is maturing as plan, as we gain further insights from our customers and develop our design and production system strategies, we continue to target the launch for later this year and entry into service for the 777-X around the end of the decade.
Airline interest in our new fuel efficient 737 MAX remain significant as we now have booked more than 1400 cumulative orders to date and have effectively bridged production from the NG to the MAX.
Today 737 airplane continues to attract strong customer interests with performance that exceeds the competition in their segments. We remain on track to increase 737 production to 42 per month in the second quarter of next year. Further, we are positioned to match production with additional demand as our customers require it.
Turning to Defense, Space & Security the U.S. fiscal year 2014 budget deliberations are well underway following the release of the President’s budget request in April. While it's still early in the congressional process the Defense and space mark-ups appear neutral to Boeing at the top level. That said, neither the President’s request nor the congressional bills reflect sequestration level spending with us.
We remain concerned about the impact that sequestration targets will have in our customers, military readiness and the industrial base. Within this context, our relative strength stems from a portfolio that is reliable, proven, affordable that is being delivered on budget and on schedule.
Despite budget pressures, growth is still emerging in those areas we have been targeting with investment and innovation, such as commercial derivatives, space, unmanned systems, intelligence, surveillance and reconnaissance and cyber security. Growth in international markets continues to help us mitigate domestic market pressures.
International Defense space and security business represented 23% of our revenue during the quarter and remains approximately 40% of our current backlog as we continue to expand our share in addressable international markets.
We also continue to strengthen our competitive position in U.S. and international Defense markets by driving further efficiency and productivity through our long-running market-based affordability effort and our partnering for success initiative that we began last year.
As many of you recall partnering for success is a long-term team oriented approach that examines opportunities across the supply chain in design, production and support to drive significant improvements in quality, flow and efficiencies. It is an enterprise wide one Boeing effort, responding to customer demands for increased productivity and lower costs in our products and services.
We are pleased with the initial response from numerous suppliers that recognize the growth opportunity they will have working with us and we expect the full benefits to our customers and suppliers to accrue over time inline with the long cycle nature of our business.
Now let’s move to a summary of the second quarter on Slide 03. Both businesses reported strong results during the quarter, as we generated healthy revenue, higher operating margin, and significant operating cash flow.
Revenue at commercial airplanes was $13.6 billion and operating margin grew to 10.7%, resulting from lower R&D, higher volume, and strong program execution. Marking our highest output level in nearly 15 years, we delivered 169 commercial airplanes in the second quarter including 16, 787s.
During the quarter, we completed all of the 787 battery system enhancements on previously delivered airplanes, and returned the full fleet to service. 787 production is progressing smoothly at a rate of seven per month and we remain on track to increase the rate to 10 per month by year-end.
With 787-9 progressing through final assembly, we’re now focused on achieving first flight later in the year, and production remains on track to support the first scheduled customer delivery next year.
Our discipline gated development process has been instrumental in the successful development of the airplane. The same process allowed us to accelerate the expected 787 MAX entry into service and is also being applied to other programs.
Turning to the Defense business, Defense Space & Security generated revenue of $8.2 billion in the second quarter, and increased operating margin, and operating profit. Numerous important contract awards were captured during the quarter including, five commercial satellite orders and a strategic international helicopter support contract.
We also finalized Chinook, and Osprey Multiyear contracts that totaled more than $10 billion. Noteworthy program milestones achieved during the quarter included the successful test fights for Phantom Eye, EMARS and our Hypersonic X51. We also began assembly on the first KC-46 Tanker, in partnership with the U.S. Air Force, we successfully conducted the critical design review on the KC-46 Tanker program in July, which is a major milestone conducted well ahead of the contract schedule.
During the quarter, we delivered the first of 15 CH-147F Chinook helicopters to the Royal Canadian Air force and delivered for launch the sixth U.S. Air Force Wideband Global SATCOM Satellite. In summary, our team delivered another strong quarter of financial results in both businesses, captured orders totaling $40 billion made good progress on our partnering for success and other productivity initiatives and as Greg will discuss returned increase valued to shareholders through share repurchase and dividend
Now I will turn it over to Greg to discuss our financial results and our guidance, Greg.
Thanks Jim and good morning. Let’s turn to the Slide 4 to discuss the results for the quarter. Second quarter revenue increased 9% to $21.8 billion driven by strong commercial airplane deliveries. Core operating margins increased to 9.3% in the quarter primarily driven by higher commercial deliveries, lower R&D and solid productivity gains at both businesses.
Core earning per share increased 13% to a $1.67 a share in the quarter on higher revenue and continued strong operating performance, again in both commercial airplanes and the Defense business.
So let’s discuss commercial airplanes now on Slide 5. For the second quarter, our commercial airplane business reported revenue of $13.6 billion on a 169 airplane deliveries and strong operating margins of 10.7%.
Higher commercial airplane operating margins were driven by increased 737 and 777 deliveries, strong core operating performance and lower R&D partially offset by the dilution of higher 787 deliveries in the quarter. Gross inventory for the company included $30.3 billion related to the 787 program, an increase from the second quarter of approximately $1.5 billion.
This increase was primarily driven by higher inventory in support of the planned production rate increases later in the year and the introduction of the 787-9 program. Included in the working process inventory are the deferred production costs. The deferred balance for the 787 program was $18.7 billion at the end of the second quarter and includes approximately 64 airplanes still in process.
The deferred production balance is still expected to peak at slightly over $20 billion and then decline as the program achieves the planned rate of 10 per month and stabilize at that level. The launch of the 787-10 did not result in any change in the 787 accounting quantity, revenue or cost estimates during the second quarter, although we do expect the 787-10 aircraft to be incorporated in these estimates later in the year as we firm up customer orders.
Commercial airplanes captured $28.7 billion of orders during the quarter, and increased backlog to a new record of $339 billion or 4,757 aircraft. Customer demand for our game-changing fuel efficient airplanes remains strong, as illustrated by the additional 246, 737 MAX orders and 50 787-10 orders in the quarter.
Turning now to Defense, Space & Security results in Slide 6. Second quarter revenue for our Defense business was $8.2 billion and operating margins grew to 9.5% again driven by strong core operating performance across the business. International customers accounted for 23% of our Defense revenue in the second quarter and we continue to drive towards our goal of 30% of revenue going forward.
Our focus on affordability continues as we remain committed to our market-based affordability efforts, we’ve already captured over $3 billion in savings. We’re on track for further lowering our cost structure in an effort to increase productivity and strengthen our competitive position in this challenging environment.
Revenue at Boeing Military Aircraft was $3.9 billion in the second quarter, primarily driven by lower F-15 and AEW and C volume. Operating margins was 9.6% in the quarter. Network & Space System revenue of $2 billion increased 5% primarily driven by improved volume on commercial satellite and the Space Launch Systems program. Operating margin is 6.7% in the quarter.
Global Services & Support had second quarter revenue of $2.2 billion and operating margins of 11.8% on strong performance at our integrated logistics business. Defense, Space & Security reported a solid backlog of $71 billion and International business was 37% of our current backlog representing customers outside the United States.
Turning now to Slide 7; the BCC net financing portfolio declined to $4.1 billion on normal runoff that exceeded new aircraft volume, unallocated expense from our core operations of $177 million was higher primarily due to an increase in deferred compensation expense driven by our higher stock price and overall stock market performance.
Turning now to cash flow on Slide 8. Operating cash flow for the quarter was $3.5 billion. The strength of our cash flow was driven by improved performance and favorable timing of receipts and expenditures in the quarter.
As a result, our strong performance and execution of our balance cash deployment strategy, we’ve repurchased 10.2 million shares for $1 billion in the quarter and we also paid a 12% higher dividend to shareholders compared to the same quarter last year. As we continue to execute to our plans, we remain focused on investing in key growth areas of our business and returning cash to shareholders.
Moving to cash and debt balances on Slide 9. We ended the quarter with over $14 billion of cash and marketable securities. Debt levels increased slightly to support aircraft financing at Boeing Capital, and our cash position continues to provide a sound liquidity and positions us well going forward.
Turning now to Slide 10 to discuss our outlook for 2013. Due to the strong performance in the first half and the outlook for the balance of the year, we’re increasing our 2013 core earnings per share guidance to be between $6.20 and $6.40 per share. Revenue guidance for the year increased $1 billion to now be between $83 billion and $86 billion reflecting higher expected volume driven by international revenue and mix at our Defense business. As a result, Defense revenue guidance increased to be between $31.5 billion and $32.5 billion.
Commercial airplane revenue guidance of $51 billion to $53 billion remains unchanged and continues to reflect higher expected deliveries in 2013. We still expect 787 deliveries to be greater than 60 for this year and deliveries relatively evenly spread over the remaining two quarters.
Total commercial airplane deliveries remain on track to be between 635 and 645 for the year.
Boeing Commercial airplane operating margin guidance is increased to be greater than 9.5% on improved performance and lower R&D. With our continued focus on development program execution, we now expect total research and development spending for 2013 to be approximately $3.3 billion, a $100 million lower than our prior guidance. Due to ramp up of 737 MAX and 787-10 investments, we do expect second half of 2013 R&D spending to be slightly higher than the first half.
Partially offsetting the favorable performance of the businesses and our higher unallocated cost and other costs, total core unallocated expenses now forecasted to be approximately $600 million for the year driven largely by deferred compensation expense again due to recent share price and stock market increases.
Furthermore, our tax rate is now expected to be approximately 31% driven primarily by lower than expected manufacturing tax credit in 2013. Operating cash flow before pension contributions guidance for the year is unchanged to greater than $8 billion. We continue to plan to make a $1.5 billion discretionary pension contribution in the third quarter.
Overall, second quarter performance was strong at both businesses as we further improved productivity, continue to execute on our new airplane development program, successfully navigated the difficult Defense environment and efficiently deployed cash to shareholders. We expect this strong operational performance to continue throughout the balance of 2013.
With that, I’ll now turn it back over to Jim for some final thoughts.
W. James McNerney, Jr.
Thanks, Greg. With a strong first half behind us and a successful launch of the 787-10, we remain committed to the goals we initially set for 2013. They include continued conversion of our record backlog into deliveries through strong core operating performance that allows us to return cash to shareholders while investing wisely in our products, technologies and people to sustain our growth and competitiveness.
Our priorities going forward remain clear. The profitable ramp up in production of our commercial airplane programs executing on our commercial and Defense development programs, driving productivity, affordability and safety throughout the enterprise, continuing to strengthen and reposition our Defense business with investments in growth areas amid further international expansion, and importantly providing increasing value to both our customers and our shareholders as we do it.
Now we would be glad to take any questions you might have.
Earnings Call Part 2: