Source: Seeking Alpha
The Boeing Company (NYSE:BA)
Q2 2014 Earnings Conference Call
July 23, 2014 10:30 AM ET
Troy Lahr – VP, IR
Jim McNerney – Chairman and CEO
Greg Smith – CFO
Ray Conner – Vice Chairman, President and CEO – Commercial Airplanes
Tom Downey – SVP, Corporate Communications
Howard Rubel – Jefferies
Carter Copeland – Barclays Capital
Doug Harned – Sanford Bernstein
John Godyn – Morgan Stanley
Cai Von Rumohr – Cowen and Company
Joe Nadol – JPMorgan
Myles Walton – Deutsche Bank
Peter Arment – Sterne Agee
David Strauss – UBS
Sam Pearlstein – Wells Fargo Securities
Jason Gursky – Citigroup
Julie Johnsson – Bloomberg News
Christopher Drew – The New York Times
Doug Cameron – Wall Street Journal
Steve Wilhelm – Puget Sound Business Journal
Stephen Trimble – Flight Global
Thank you for standing-by. Good day everyone and welcome to the Boeing Company’s Second Quarter 2014 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 introductions, I am 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 2014 earnings call. I am Troy Lahr and with me today are Jim McNerney, Boeing’s Chairman and Chief Executive Officer and Greg Smith, Boeing’s Chief Financial Officer. After comments by Jim and Greg, we will take your questions. In fairness to others on the call, we ask that you please limit yourself to one question. As always, we have provided detailed financial information in today’s press release and you can follow this broadcast and slide presentation through our Web site at boeing.com.
Before we begin, I need to remind you that any projections and goals included in our discussion this morning are likely to involve risk, which is detailed in our news release and our various SEC filings and in the forward-looking statement disclaimer at the end of this 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 will turn the call over to Jim McNerney.
Thank you, Troy and good morning. Let me begin today by acknowledging the families of loved ones of those aboard Malaysia Airlines Flight 17. All of them and everyone affected by this horrific tragedy are in our thoughts and prayers at this time. For the men and women and Boeing and others throughout our industry who are passionately committed to ensuring the safety and security of passengers and air crews, this is a particular unsettling and painful moment in the history of civil aviation. We are providing technical assistance to the investigation at the request of the NTSB which is supporting international authorities in the important work they have underway.
Turning back to the subject at hand this morning, I’ll start with some comments on the quarter and our business environment. After that Greg will walk you through details of our financial results and outlook.
Now let’s move to Slide 2. Boeing delivered strong quarter operating performance across our production programs and services businesses with solid revenue, double-digit core EPS growth and healthy cash generation. Our strong positive performance through the first half of the year has allowed us to continue returning cash to shareholders and increase guidance for our full year EPS by $0.75 which includes approximately a $0.50 tax benefit. Greg will discuss guidance in more detail in just a couple of minutes.
During the second quarter we did record a 272 million after tax charge on our fixed price U.S. Air Force tanker program engineering and manufacturing development contract. The charge was driven by higher spending needed to complete systems installation on the tanker to test that aircraft and maintain the schedule for delivering this vital capability to the war fighter. As you may recall we noted in our Investors Conference that we were beginning to see some challenges in the build and systems installation process. The increased spending is primarily related to additional engineering and systems installation rework required mainly to meet wiring specifications.
The issues at hand are well defined and understood which in no way mitigates our disappointment in having to take this charge, but the actions we have taken to keep us on path to the next major program milestone which is to begin test line fully provisioned tanker aircraft in the first part of next year. With a long-term potential market for the KC-46 tanker of up to 400 airplanes worth $80 billion, it remains a franchise program for Boeing. And we expect to realize strong returns over decades of production and in service support.
With that said let’s discuss our core operating performance during the quarter. Revenue at Boeing Commercial Airplanes was $14.3 billion and operating margins increased to 10.8% a result of both the higher volume and a favorable delivery mix. We delivered 181 commercial airplanes in the second quarter including 37 87-Dreamliners and we added net new orders of 264 airplanes. So far in July we have booked another 282 orders including those announced by customers at the Farnborough International Airshow bringing our current net order total to 783 for the year already a book-to-bill greater than 1.
Boeing Defense Space and Security reported revenue in the second quarter of 7.7 billion. During the period BDS captured numerous key contract awards including a $1.9 billion order of 44 U.S. Navy and Royal Australian Air Force E/A 18 and F/A 18 aircraft, a $700 million order for five years of AEW&C in service support from the Royal Australian Air Force and a $200 million order for our 9th 702MP Intelsat satellite. Significant program milestones included a successful missile defense system intercept test delivery of both the 4th P-8A, P-8I to India and the 100th P-18G to the U.S. Navy.
With that let’s turn to the business environment on Slide 3. Global demand remains high for the superior fuel efficiency and economics provided by our family of commercial airplanes as recognized in the order totals I’ve mentioned earlier. Global passenger traffic trends continue to be healthy and air cargo traffic is still gradually improving. In addition to growth driven demand we continue to experience and foresee sustained high replacement demand where newer more efficient airplanes offer compelling economics and a rapid return on investment compared to keeping older less efficient airplanes in service.
Combining growth and replacement needs over the next 20 years we forecast global demand for nearly 37,000 commercial airplanes a 4% increase over the last year’s forecast. Deferral requests from customers are still running well below at historically average while request to accelerate deliveries remain brisk. This ongoing strong demand coupled with our already sizable and diverse backlog of more than 5,200 airplanes reinforces our planned production rates and outlook for sustained growth in the years ahead.
In the Twin-Aisle segment we continue to see healthy demand for both the 777 and the 777X which continue to out sell the competition by a wide margin giving us confidence in our ability to transition between the two airplanes. As part of our focus on that transition we are looking to maximize production efficiencies with existing best practices from other programs as well as advanced new manufacturing technologies. For example last week we unveiled a new robotic system for building 777 Fuselages this automated approach will increase first time quality reduce build times and improve work place safety for our employees.
On the 787 program we achieved major milestones with certification of 330 minute ETOPS and the on schedule certification in first delivery of the 787-9 to Air New Zealand. Development of the 787-10 also is progressing to plan with the first delivery in 2018. In the Single-Aisle segment demand for our new fuel efficient 737 MAX remains high with cumulative orders exceeding 2,100 airplanes from 43 customers, the production bridge from today’s 737 to the MAX remains solid with the first MAX delivery in 2017.
Turning to Defense, Space & security, we continue to see solid support for our major programs in the FY15 budget process. We are encouraged by the actions taken in both the house and senate appropriations committees with regard to additional P-8s, Apaches and EA-18G aircraft. International Defense, Space & security business represented nearly 30% of BDS revenues during the quarter and remains at approximately 35% of the BDS backlog as we continue to leverage our unique One Boeing global advantage.
Our investments in technology and innovation for organic growth continue in areas such as commercial derivatives, space, unmanned systems, intelligent surveillance and reconnaissance, cyber security and the few but critical future large-scale programs identified as priorities by our customers like Long Range Strike, UCLASS and the T-X Trainer. The relative strength of our Defense, Space & Security business stems from a portfolio that is reliable, proven and affordable and is being delivered on budget and on schedule. We remain intensely focused on driving further efficiency, quality and productivity gains to improve program profitability and fund investment and future growth.
Defense, Space & Security continues to make great progress on our market-based affordability initiative as we strive to take out another $2 billion in operating costs. Along those lines benefits from our enterprise partnering for success approach with suppliers continue to accrue. For example in collaboration with our partner Japanese aircraft industries we’re reducing cost of producing various 777 parts through value engineering, a great joint effort that will help ensure the continued competitiveness of the 777 airplane in the marketplace.
In summary, notwithstanding our disappointment over the charge on tanker our team delivered another strong quarter of core operating performance, captured meaningful growth through new business and made great progress on further improving productivity and achieving important program milestones for us and our customers.
Now, over to Greg for our financial results and our updated guidance, Greg?
Thanks Jim and good morning. Let’s turn to Slide 4 to discuss our second quarter results. Second quarter revenue of $22 billion was driven by 7% increase in commercial airplane deliveries and higher commercial services volume. Core operating margins of 9% reflects solid productivity gains on production programs and across the services businesses offset by the impact of the tanker charge.
Second quarter core earnings per share increased 45%, $2.42 a share on additional tax adjustments, higher commercial volume, and continued strong operating performance on core production programs. During the quarter, we recorded a tax benefit of $116 million for the 2007 and 2008 tax settlements that we discussed in April as well as an additional $408 million tax benefit related to the 2009, 2010 tax settlement and the tax basis restoration.
The $425 million pretax charge or 272 million on an after-tax for the tanker program largely relates to additional engineering and manufacturing labor associated with challenges we encouraged in the wire installation as we move into the systems integration stage of final assembly on the initial test aircraft.
As we said before given the significant long-term Tanker market opportunity as Jim discussed, we bid the EMD phase with the Tanker program aggressively with zero margin with plant profitability generated during the production phase. Looking at our overall performance to-date on the program, we have met all customer milestones and are proceeding with functional testing to be followed by the start of the initial Tanker flight testing in early part of next year.
As Jim noted despite our disappointment in encountering these challenges, the issues are well understood, no new technology is required to resolve them. And we believe the program is sufficiently provisioned and has a solid path forward. We are confident we’re taking the right steps to fulfill our promises to our customer. Excluding the Tanker performance encountered in the quarter, we continue to make great progress across other areas of the business. Let’s now turn to commercial airplanes on Slide 5.
For the second quarter, our commercial airplane business increased revenue 5% to 14.3 billion on 181 aircraft deliveries and including a record 124 737s and 30 787s. The business also increased operating margins in the quarter to 10.8%. Higher volume and our focus on efficiently executing on our rate increases and continuously driving productivity led a strong operating performance during the quarter than more than offset the $238 million pretax charge related to the EMD Tanker contract at BCA.
Commercial airplanes captured $17 billion in net orders during the quarter and backlog remained very strong at a new record of $377 billion over 5,200 aircraft equates to approximately seven years of production. In the second quarter while at a declining rate 787 deferred production increased $1.1 billion to 24.2 billion, largely driven by increase in our rate of production on the 787-9 and inventory pull ahead to efficiently optimize our production and minimize -8 disruption as we introduced the aircraft into our production system.
Based on further production stability, plant contracted higher step down pricing and continued overall productivity improvements. We expect the quarterly change in deferred to improve over the remainder of the year. The cash flow profile of the 787 continues to improve as we drive productivity throughout the production system. We continue to see good progress on key operational performance indicators and unit cost as we further implement production efficiencies and increase 787-9 production.
As we continue our efforts to optimize the production system and maximize efficiencies at the 10 per month rate, the team continues to make progress in reducing 787-8 unit cost by approximately 13% and improved final assembly flow times by more than 10% over the past year. Travel work has also been significantly reduced declining by greater than 30% since this time last quarter. We are also continuing to see good progress in the 787-9 productivity where we’ve seen 50% improvement in unit cost and a 25% improvement of flow time from the first aircraft to the seventh aircraft to rollout the factory.
Overall, we’ve made solid improvement on the 787 program. However, great deal of work ahead of us as we increase -9 productions, introduce the -19 into early stages of our production system and continue to optimize to drive further productivity and profitability on the program. We remain on track to deliver approximately 110 787s in 2014 and again the team remains focused on day-to-day execution and improving long-term productivity and profitability on the program.
Let’s now turn to the Defense, Space & Security results on Slide 6. Second quarter revenue for our Defense business was 7.7 billion and operating margins were 7.5%, a strong performance on production programs and favorable delivery mix offset by the $187 million pretax charge on the EMD Tanker contract. Boeing military aircraft second quarter revenue declined to $3.5 billion reflecting delivery mix and operating margins of 4.7% in the quarter again impacted by the tanker charge.
Global Services and Support revenue at 2.3 billion reflects slightly lower volume in the maintenance mod and upgrade business and strong operating performance across that business drove operating margins to 11.6%. Network and Space systems reported revenue of 1.9 billion on lower commercial satellite volume and generated operating margins of 7.8% in the quarter. Defense Space and Security reported a solid backlog of $63 billion with 36% of our current backlog now from international customers.
Now turning to Slide 7, Boeing Capital’s net financing portfolio declined to $3.4 billion on run-offs that exceeded new aircraft volume.
Now look at cash flow on Slide 8. Operating cash flow for the second quarter was 1.8 billion driven by solid operating performance and timing of receipts and expenditures. With regards to capital deployment we paid $530 million in dividends to shareholders and repurchased 11.4 million shares for $1.5 billion in the second quarter. We continue to anticipate completing the remainder of 6.8 billion repurchased authorization over approximately the next two years. Returning cash to shareholders along with continued investment to support future growth remains the top priority for us.
Moving now to cash and debt balance on Slide 9, we ended the quarter with $11 billion of cash and marketable securities and our cash position continues to provide solid liquidity and positions us very well going forward.
Turning now to Slide 10 to discuss our outlook for 2014, we’re increasing our core earnings per share guidance for 2014 by $0.75 to now be $7.90 to $8.10 a share reflecting the $408 million tax benefit and strong core operating performance that more than offsets the impact of the tanker charge. Guidance for revenue, operating cash flow and delivery remains unchanged. Commercial airplane operating margin guidance for 2014 has increased, to now be greater than 10% on continued strong operating performance.
Over the remainder of the year we anticipate BCA margins to be impacted by higher 787 deliveries, some additional fleet support and additional investments in productivity initiatives. Defense Space and Security operating margin guidance for 2014 is unchanged at approximately 9.5% with lower margin guidance in BMA, offset by higher guidance into the DS&S business.
In summary second quarter performance reflects the strength of our backlog, the strong demand for our products and services and our continued focus on driving productivity throughout the entire enterprise. And furthermore as evidenced by the meaningful dividend increase and a higher share repurchase activity we continue to expect to deliver solid growth, productivity and strong cash flows going forward.
With that I’ll turn it back to Jim for some closing comments.
Thanks Greg. With a strong first half behind us and the team that is focused on sustained strong business performance we’re ready and committed to deliver on our strengthened outlook for the remainder of 2014. Our priorities remain clear, the profitable ramp up in production on our commercial airplane programs executing on our commercial and defense development programs with the emphasis on tanker, driving productivity and affordability throughout the enterprise, continuing to strengthen and position our defense business with investments in growth areas midst further international expansion and all the while providing increasing value to both our customers and shareholders.
With that said we’d now be happy to take your questions.