Boeing Company (BA) — Q4 2018 Earnings Call Transcript

Thank you, and good morning. Welcome to Boeing's fourth quarter 2018 earnings call. I'm Maurita Sutedja. And with me today is Dennis Muilenburg, Boeing's Chairman, President and Chief Executive Officer; and Greg Smith, Boeing's Chief Financial Officer and Executive Vice President of Enterprise Performance & Strategy. After management comment, 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 our press release issued earlier today. And as a reminder 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 include in our discussion this morning are likely to involve risks, which are detailed in our news release in our various SEC filings and in the forward-looking statement disclaimer at the end of this presentation. In addition, we refer you to our earnings release and presentation for disclosures and reconciliations of non-GAAP measures that we use when discussing our results and outlook. Now, I will turn the call over to Dennis Muilenburg.

Thank you, Maurita, and good morning. Let me begin today with a brief overview of our 2018 operating performance, followed by an update on the business environment and our expectations going forward. After that, Greg will walk you through the details of our financial results and outlook. With that, let's move to Slide 2. Thanks to the dedicated efforts of our teams across the company, Boeing delivered strong 2018 financial results that included record revenue, earnings per share and operating cash flow, driven by record commercial aircraft deliveries, higher defense, space and security services volume and strong performance. All of our three businesses increased their backlog in 2018. We sharpened our focus on profitable, sustained long-term growth strategies, disciplined execution of our production and development programs, delivering greater life cycle value, including growing our services business and driving further quality, safety and productivity gains across the enterprise. For the full year, we generated record operating cash flow of $15.3 billion. We repurchased 26.1 million shares for $9 billion and made dividend payments totaling $3.9 billion in 2018. We continue to deliver on our commitment to returning cash to shareholders while investing in our people, innovation and future growth. In December, our Board of Directors authorized a new $20 billion share repurchase program and a 20% increase in our quarterly dividend. The increase is a part of our balanced cash deployment strategy and reflects the confidence we have in our strong lineup of products and services in our long-term outlook for the business. Turning to our core operating performance for the year, Boeing Commercial Airplanes generated revenue of $60.7 billion reflecting a record 806 deliveries, including the delivery of the first 787–10 Dreamliner and the first 737 Max 9. During the year, we delivered 256 Max airplanes nearly half of the total 737 deliveries. Continued healthy sales activity contributed to 893 net new airplane orders during the year, adding to our robust backlog which stands at nearly 5,900 airplanes and is worth $412 billion. Our backlog equates to about seven years of production at current rates. Commercial Airplane milestones in 2018 included the delivery of the 787 Dreamliner and the first airplane from the new 737 completion center in China. The 737 program increased its production rate to 52 per month and made good progress on its recovery plans to mitigate supply chain challenges with the 173 aircraft delivered in the fourth quarter. Also in the year, we completed the first flight of the 737 Max 7 and delivered the first Max Boeing business jet airplane. The 777X program achieved a number of key milestones last year as we rolled out the static test airplane and began production of the flight test airplanes. We recently completed the Final Body Join for the first flight test airplane and turned on its electrically powered systems. We plan to start flight testing this year and remain on track for the first 777X delivery in 2020. Meanwhile, the 787 program further matured its rate readiness. We have started transitioning to 14 per month in our factories and supply chain as we prepare to begin delivering at this higher rate. We expect to complete the transition in the second quarter. Now over to Defense, Space & Security. BDS reported revenue of $23.2 billion, a 13% growth year-on-year, reflecting higher volume across its business. BDS booked $36 billion of new orders during the year, including wins on important new franchise opportunities like the T-X trainer, the MQ-25 unmanned aircraft and the MH-139 helicopter. More recently, in the fourth quarter, BDS was awarded contracts to modernize the entire Spanish Chinook Helicopter fleet and a joint ground system to provide tactical satellite communications for the U.S. Air Force. BDS made progress on a number of critical program milestones, including delivering the first two KC 46 tankers to the U.S. Air Force earlier this month. Two more tankers have been accepted by the Air Force, and we expect to deliver these aircraft imminently. We look forward to working with the Air Force and the Navy during their initial operational test and evaluation of the KC-46, as we further demonstrate the operational capabilities of this next generation aircraft across refueling, mobility and combat weapon system missions. Additionally, we received the contract to provide the second KC-46 international tanker to Japan. This highlights the broader demand and market opportunity that we see for this program. Other key operational milestones for BDS included the unveiling of the SB-1 Defiant helicopter Boeing and Sikorsky are developing for the U.S. Army's Joint Multirole Technology Demonstrator Program and completing another Minuteman III flight test. We continue to ramp up the activities for the T-X and MQ-25 programs. These wins are the culmination of years of unwavering focus, improving our technology and derisking the programs. We have developed and flight tested two all-new production-ready T-X jets with 76 flight tests having been completed to date. We've already seen strong interest as well for the T-X from outside of the U.S. On MQ-25, we have demonstrated deck handling and engine trials. Our MQ-25 prototype aircraft is currently in ground test and is expected to undergo its first flight this year. Now turning to Global Services. BGS reported revenue of $17 billion, representing 17% growth year-on-year. Business operations began in July of 2017. BGS growth consistently outpaced the average for the services market. BGS continues to win new business, highlighting the value we bring to our broad range of commercial and government customers and the strength of our One Boeing offerings. BGS booked new orders totaling approximately $18 billion in 2018. The awards included support services and sustainment contracts for military customers globally such as the recent C-17, F-18 and F-22 contracts with U.S. Navy and Air Force and F-15 for Qatar. In addition to the strong momentum in its parts and supply chain business, BGS continues to expand its market-leading digital solution portfolio and customer base. In the fourth quarter, more than 5,300 commercial and military aircraft were monitored in flight by Airplane Health Management, a cloud-based real-time health monitoring solution. Adding to the list of our digital analytics customers, Shenzhen Airlines recently signed up for crew pairing and rostering services. Shenzhen will be the first airline in China to use Boeing analytics-powered crew management solutions, bringing the most advanced data analytics capabilities to the airline, allowing them to focus on their core business of serving their customers while improving efficiency and cost. In the fourth quarter, we also completed the acquisition of KLX, a major global provider of aviation parts and services. Boosting our supply chain capability enables us to better serve our customers while profitably and purposefully growing our business. Our integration activities continue to progress well. We've retained the top KLX talent and are on track to achieve or exceed our business case synergy value. Additionally, last year we started operations for our airplane seat joint venture with Adient, and an Auxiliary Power Units joint venture with Safran. These partnerships support Boeing's vertical integration strategy to strengthen in-house capabilities and depth in key areas to offer better products that deliver greater value to our customers, grow our services business and generate greater life cycle value. We've also made progress in our strategic partnership with Embraer. We've recently received approval from the Government of Brazil and signed definitive agreements with Embraer. The Embraer shareholder votes scheduled for February 26 is the next major milestone. Over the coming months, we'll continue to work with Embraer, global regulators and other stakeholders to complete the transaction and create the most important strategic partnership in the aerospace industry. Assuming the approvals are received in a timely manner, we expect to close the transaction by the end of this year. In summary, we delivered another year of strong operating performance, captured noteworthy additions to our large and diverse backlog, returned significant cash to our shareholders, invested in our people and in our business to drive innovation and excellence and complemented our organic growth with planned strategic inorganic investments. With that, let’s turn to the business environment on Slide 3. We continue to see healthy global demand for our offerings in commercial, defense, space and services. These are sizable sectors that are growing and backed by strong fundamentals with a combined market opportunity of $8.1 trillion over the next 10 years. I would note that as a global company with customers in 150 countries, we're always mindful of the potential impact of geopolitical and macroeconomic forces. We continue to track a host of near-term issues and mitigate potential risks as appropriate. We value and maintain strong relationships with our customers, suppliers and other stakeholders around the world, reinforcing the mutual economic benefits of the strong and prosperous aerospace industry.

Great. Thanks, Dennis. Good morning, everybody. Let's turn to Slide 4, and we'll discuss our full year results. We booked record revenue of $101 billion in 2018, exceeding $100 billion for the first time in the company's history. This is driven by record commercial aircraft deliveries, higher Defense, Space & Security volume and continued growth in services. Core earnings-per-share totaled $16.01 for the full year, another record reflecting higher volume, improved mix and solid execution across the company. Operating cash flow for the year was also a record at $15.3 billion. The robust cash generation was largely driven by higher volume and strong operating performance across the businesses. Let’s move now to our quarterly results on Slide 5. Fourth quarter revenue increased to $28.3 billion driven by growth in all three businesses while core earnings per share grew to $5.48, driven by higher volume and strong operating performance across the portfolio, which outweighed the favorable tax reform impact in the fourth quarter of last year. Now let's discuss Commercial Airplanes on Slide 6. Our Commercial Airplane business revenue of $17.3 billion during the quarter reflected higher deliveries and favorable mix. BCA operating margins increased to 15.6%, driven by higher 737 volume and strong operating performance on production programs, including higher 787 margins. BCA captured $16 billion of net orders during the fourth quarter and the backlog remains strong at $412 billion with nearly 5,900 aircraft, representing approximately seven years of production. We delivered 238 aircraft in the quarter, including 173 737s. And as we discussed, the 737 deliveries for the year were back-loaded due to production and supply chain recovery efforts. Let's now turn to Defense, Space & Security results on Slide 7. Fourth quarter revenue increased to $6.1 billion driven by higher volume across the BDS portfolio, including F-18 satellites and weapons. BDS margins increased to 10.9%, reflecting solid performance and favorable mix. BDS added $5 billion of new orders in the quarter, bringing its backlog to $57 billion with 30% of that from outside of the United States. Turning now to Global Services results on Slide 8. In the fourth quarter, Global Services revenue increased by $4.9 billion, reflecting higher volume predominantly driven by increased sales of parts and supply chain solutions. Year-over-year growth of 17% for the full year, which was predominantly driven by organic growth, more than meets our objective to outpace the average annual service market growth rate of 3.5%. BGS operating margins were strong at 15%, reflecting the mix of products and services in the quarter, as well as improved performance, partially offset by higher period costs for investments focused on expanding our portfolio of offerings going forward. During the quarter, BGS won key contract awards worth approximately $6 billion, bringing our backlog to $21 billion. These wins underscore the strength of our One Boeing offerings to our customers. Let's turn now to cash flow on Slide 9. Operating cash flow for the quarter and full year was strong at $2.9 billion and $15.3 billion respectively. These results were driven by planned higher volume, strong operating performance across the business and some timing of receipt and expenditures. We remain focused and on track with our balanced cash deployment strategy. In 2018, we invested $5 billion in R&D and CapEx, repurchased $9 billion of Boeing stock and paid $3.9 billion in dividends reflecting a 20% increase in dividend per-share from last year. And we also completed the KLX acquisition in the fourth quarter. The strength of our business and our confidence in the sustainable long-term outlook are powering investments in productivity, innovation and growth, while delivering on our commitments to return cash to shareholders. As Dennis mentioned earlier in December, last year we reinforced our commitment to returning value to shareholders as our Board of Directors authorized a new $20 billion share repurchase program and a 20% increase in our quarterly dividend. Over the last five years, we've repurchased more than 205 million shares and increased our dividend by more than 180%. At the same time, we've invested nearly $35 billion in key strategic areas of our business to support long-term growth sustainability for Boeing, for our customers and our shareholders. We remain committed to continue to execute on our balanced cash deployment strategy going forward.

Let's move now to cash and debt balances on Slide 10. We ended the quarter with $8.6 billion of cash and marketable securities, $13.8 billion of debt and stable credit ratings. Our cash and debt position reflects the acquisition of KLX in the fourth quarter. And our balance sheet position continues to provide us with flexibility to invest in innovation and profitable growth opportunities while again returning value back to shareholders. Turning now to Slide 11 to discuss our outlook for 2019. Building on the strong performance in 2018, our guidance for 2019 reflects higher volume, improved core operating performance, additional productivity capture and continued focus and effort to drive growing cash flows. Total company revenue for 2019 is forecasted to be between $109.5 and $111.5 billion, largely reflecting higher planned 737 and 787 production rates and growth in both services as well as defense, space, and security. Core earnings per share guidance for 2019 is set to be between $19.90 and $20.10 per share on higher volume, favorable mix and improved productivity and affordability. Operating cash flow for 2019 is forecasted to increase by $2 billion to be between $17 billion and $17.5 billion. This is largely driven by improved 787 cash generation in 2019, higher overall volume, including 737 and 787 production and improving tanker cash profile that is partially offset by increased planned 777X inventory related to test aircraft and early build units and higher cash taxes, primarily due to improved unit profitability, as well as higher planned R&D spending in 2019. Capital spending is forecasted to be approximately $2.3 billion and includes the timing shift of some expenditures that were expected in 2018. Our investments align with our long-term growth and productivity strategy that supports for programs, innovation, productivity verticals and services. And before we discuss the business unit guidance, I would like to highlight that beginning in January 2019, we are changing the realignment of our military derivative aircraft contracts, such as the KC-46 tanker, P-8 Poseidon and VC-25, Air Force 1 between BCA and BDS. This change is to better reflect the contractual relationship with the end customers as BDS calls the prime contract. This accounting realignment does not change how BCA and BDS execute together on these contracts. Also it does not affect total Boeing sales, earnings, assets, cash flows or liabilities. Our 2019 segment guidance includes the impact of this realignment, and beginning in January 2019, revenue and costs associated with military derivative aircraft that were previously reported in both BCA and BDS will now be 100% reported in the BDS segment. For comparison purposes as part of the earnings release, we provided restated 2018 and 2017 financial information incorporating this accounting change.

Now, for 2019, commercial airplane revenue guidance is set to be between $64.5 billion and $65.5 billion. And as we've discussed this is largely driven by the higher deliveries of 737 and 787 programs, partially offset by the impact of the military derivative aircraft realignment to BDS. The ramp up on the 737 Max production continues and we expect the 737 Max to account for approximately 90% of total 737 deliveries in 2019. In all, BCA expects to deliver between 895 and 905 airplanes for the full year. Incorporating this delivery guidance assumptions, our planned 737 and 787 production rate increases and the intercompany deliveries of the military aircraft from BCA to BDS. Commercial Airplane operating margin guidance is set to be between 14.5% and 15% on higher 737 volume and improved operating performance, which more than offset the higher period costs including R&D. The margin guidance also reflects all planned production rate increases. Defense, Space & Security revenue guidance for 2019 is between $26.5 billion and $27.5 billion, reflecting the higher volume in our new programs, strong backlog in core programs and the impact of the military derivative aircraft realignment from BCA. Operating margin guidance for defense business is greater than 11% based on continued productivity efforts across the portfolio, offset by less favorable mix. Global Services revenue guidance is set to be between $18.5 billion and $19 billion with operating margins of greater than 15%. BGS margin guidance reflects solid performance, a mix of products and services, as well as investments to expand our portfolio of offerings. And as we discussed, we aim to grow faster than the average service market growth rate of 3.5%, as we expand our broad service offerings and gain market share while maintaining and growing margins. We expect research and development spending to increase to approximately $4.1 billion in 2019, with approximately 60% related to BCA as we invest in future growth. BDS and BGS also continue to invest in key strategic growth opportunities and productivity enablers. In addition, we will continue to make investments at the corporate level for technology and innovation, with enterprise applicability. This 2019 R&D forecast also includes some timing shifts of some expenditures previously planned in 2018. Our R&D funding will continue to be focused on our core programs, key future franchises, productivity enablers such as automation, prototyping and capabilities to further our vertical content, lifecycle capture, and other key growth areas such as economy and mobility solutions. We will continue to make the required investment in innovation and technology to ensure our products and services continue to win in the marketplace. Going forward, we expect our overall R&D spending as a percentage of revenue to be relatively stable. While our organic investment remains the primary engine for growth, we may partner with other industry players in investments that accelerate our lifecycle value strategy and strengthen our vertical capabilities and content, as demonstrated by the proposed strategic partnership with Embraer, which assuming all approvals are received in a timely manner we expect to close by the end of the year.

Now, consistent with prior years, and given the seasonality of our business, as we look into the next quarter, we expect first quarter to be the lowest quarter of the year for revenue. With the relatively light commercial airplane deliveries, January is expected to have slow delivery activity consistent with prior year trends and reflects the supply chain recovery plans. Core EPS is estimated to be approximately 20% of the full year earnings, and first quarter operating cash is forecasted to be approximately 10% to 15%, again driven by lower volume and the timing of receipts and expenditures. As we look towards the remainder of the year, our key focus areas are continuing to manage the 737 recovery progress within our factories and throughout our supply chain, including assuring rate readiness for a smooth transition to 57 a month, also working together with our U.S. Air Force customer delivering additional KC-46 tankers, continuing healthy order momentum, especially for our new program such as the 777X, as well as strong execution across the portfolio including T-X and MQ-25 development. So in summary, our core operating engine continues to deliver strong results. We continue to use our three business unit strategy as a key differentiator to win in the marketplace, make prudent strategic investments and leverage the talent and innovation from across the company. At the same time, we will set challenging goals and objectives around elements of operations and support functions tied to profitability and efficiency to generate cash, improve working capital while driving value to our customers. All these will help us achieve our growth goal to grow year-over-year revenue, margins and cash flow. With that, I'll turn it back to Greg for some closing comments.

All right. Thanks, Dennis. 2018 was the year of strong performance and record results on many different fronts operationally and financially. A demonstration of how our team remains focused on further driving both growth and productivity. These results were achieved through the hard work and dedication of our employees and the great partnerships that we have with our customers and suppliers. In addition to the strong commercial airplane market dynamics I mentioned earlier in my remarks, we have taken our own actions to reduce cyclicality in our business. This includes remaining disciplined in our production rate decisions, derisking our pension liabilities, strategically phasing our research and development spending, creating labor stability with long-term contracts, and expanding our services business, which is also less cyclical. We've executed on our long-term strategy of robust and continuing organic growth investment and returning value to shareholders, complemented by strategic acquisitions and partnerships that enhance and accelerate our growth plans. The planned strategic partnerships with Embraer, the recent KLX acquisition, and the seats and APU joint ventures are entirely consistent with the strategy. Our priorities going forward are to leverage our unique One Boeing advantages, continue building strength on strength to deliver and improve on our commitments and to stretch beyond those plans and sharpen and accelerate our pace of progress on key enterprise growth and productivity efforts. As always, we'll continue to keep a close eye on the geopolitical and macroeconomic forces and prudently manage the risks. Achieving these objectives will require a clear and consistent focus on the profitable ramp-up in Commercial Airplane production, continuing to strengthen our Defense, Space & Security business, growing our integrated services business and leveraging the power of our three business unit strategy, delivering on our development programs, driving world-class levels of productivity and performance throughout the enterprise to fund our investments in innovation and growth, disciplined leading-edge investments and a balanced value-creating cash deployment strategy and continuing to develop and maintain the best team and talent in the industry, all of which position Boeing for continued market leadership, sustained top and bottom line growth and increasing value for our customers, shareholders and employees and other stakeholders. With that, we will be happy to take your questions.

On the 737, at what point do you expect to be caught up on deliveries? And what are the pressure points identically? Also, how does that inform the latest thinking and timeline on decision beyond 57 a month?

Certainly, 737 production system health remains a key focus for us. As you can see by the fourth quarter deliveries with 173 in the quarter and 69 in December, good signs of recovering to our production plan. You can also see the increased rates reflected in our full-year guidance for deliveries for 2019, as we continue to ramp up. I would say we still have work to do on the recovery efforts. We have seen some good solid progress. We still have work to do inside our own factories and in our supply chain. And that is the daily and weekly focus for us, very intense effort. I'll say within the supply chain, we have seen some solid recovery in several areas. We still have some areas that need work including engines. And we are doing some additional work with CFM, including deploying some additional Boeing personnel to their factories and to their sub-tier suppliers. So that’s one area that will have some additional focus for us in the first quarter. And as Greg mentioned, just in terms of production profile for the year, we expect the first quarter to be the lightest quarter of the year, and we expect January to be the lightest month within that quarter. So we are going to continue to work hard on production system holds and recovery. And then as you alluded to, at the same time, we are moving forward on our plans to ramp up to 57 a month during the year. Some elements of the supply chain have already moved to that position. We still have some work to do before we move the entire line to 57 a month. And we are going to be very, very disciplined in that process. Again we are making good progress. We know exactly what needs to be done, but we are going to just look at this through very clear eyes and step through it day-by-day, week-by-week, and make sure that we in a very disciplined and smooth way move to 57 a month. I think we learned some lessons from the 52 a month step that we did last year. And those lessons are certainly being applied this year on the 57 a month rate changes. But you see all of that again reflected in our plans and our guidance for 2019.

Could you catch us up on your latest thinking on the NMA? And maybe tie that to your view on moderating demand. I guess, demand would obviously fluctuate a bit if you chose to launch the aircraft with the pile of launch customers, I would imagine. So maybe just juxtapose those two different points.

First off, regarding the NMA, we are still following the disciplined decision-making process we previously discussed. We are making progress and have had productive conversations with customers. We understand the market needs, and it's evident there is demand, but we are still working through the business case details. As mentioned, we will remain disciplined in our approach. Although we are making progress, we have not yet reached our decision point. To clarify, we anticipate reaching a decision this year about whether to offer the airplane in the market. We need to finalize the business case analysis before making that call, but it is something we aim to decide on this year. Depending on the market response, we will make the final launch decision next year. This is a two-step decision process, consistent with how we operate in Commercial Airplanes, and we are continuing to develop and mature the technologies, reducing risk parallel to ensuring a 2025 entry into service, which we believe is important to our customers. Our assessment of the market and its size remains unchanged. Regarding orders and the market outlook, we see strong demand signals reflected in this past year’s orders volume with 806 deliveries and 893 orders. While we expect some moderation or timing adjustments on orders moving forward, we maintain a robust seven-year backlog. Considering the traffic growth stats and global expansion of route structures, the fundamentals are very strong, encouraging steady order volume, which I don’t expect to majorly change based on the NMA decision. We will continue to compete and succeed in the marketplace. One more note on the NMA: if we decide to move forward with the authority to offer, we don't expect significant changes in our R&D profile. This is part of our planned R&D profile, and as Greg mentioned earlier, we expect R&D to remain consistent as a percentage of revenue going forward. Therefore, as revenue increases, R&D will also grow proportionally. If we launch the NMA, it will align well with the timeline for the 777X. Greg, do you want to add anything to that?

No. Thanks. We got it.

So your margins of BCA are now in your target area of the mid-teens, with the 2019 guidance where it is. And you're still not fully ramped with production rates as more upside there, and you built the higher R&D into the '19 forecast. So I wanted to ask how much of this 2019 improvement in margins is volume versus mix versus productivity? And with the supply chain initiative still ongoing, what is your longer term margin potential now? How much further can you go? I was going to ask you how much it differs with and without a new airplane. But I think you just answered that part. So the components of the improvement in 2019 and then what the potential is long-term not that you've gotten this far.

Yes, that's a great question, Rob. I would say the improvement comes from all those factors. The increased volume is certainly a significant contributor, but the mix of that volume also plays a crucial role. We've discussed our focus on the 787 program, particularly with the flawless introduction of the -9 and -10 models into the market, and our commitment to ensuring a smooth ramp-up while we increase the production rate. You witnessed this in 2018, and you can expect to see it in 2019 as we aim for a rate of 14 aircraft per month. Our productivity strategy remains consistent with what we've implemented over the past few years, identifying opportunities where we can apply best practices. This initiative is part of our One Boeing approach and encompasses numerous strategies, including leveraging experiences from the F/A-18 program to improve the 787 and applying lessons from the 787 to the Chinook program and vice versa. This strategy is now ingrained in our operational practices and influences how we and the company are rewarded. This alignment extends to our supply chain as well. Our partnership for success initiative targets productivity gains that can enhance the supply chain's effectiveness and contribute to our bottom line while allowing for reinvestment in future growth. So, in summary, I would say all three factors contribute, and I encourage you to think of it as part of the same strategy we've been using for the last couple of years. Additionally, we are benchmarking ourselves against top global industrial standards, continuously assessing our operational costs and efficiency with capital and R&D. We incorporate best practices from outside our industry to align with our operating methods and hold ourselves to high standards that go beyond mere industry averages. We are determined to remain accountable and strive to achieve our goals. Thus, we maintain the same strategic approach, consistently seeking new opportunities and striving to excel.

It is your pace of improvement because you hit your target or at least you will in '19 based on the guidance. And again, you are not done improving the organization. So is there a new target?

Rob, we are not slowing down. So as we said we set a target. We've been aggressively pursuing that. We've made some great progress and part of the team's efforts there. But the competition is only getting tougher, and we are not going to slow down. So the pace of progress you have seen is the pace of progress we aim to sustain. And what we are looking for is continued year-over-year margin and cash flow growth. That's part of our planning. That's the framework that we set up for the team. And we are going to push with that pace.

Greg, I would like to get a couple of clarifications about the quarter and then ask a question regarding the guidance. Concerning the figures you've reported, I wanted to confirm the unit earnings. It appears that the 737 is still slightly below your program margin, but not by much. Also, regarding the deferred margin for the 787, it seems that there was an expansion that helped keep the deferred amount down. Is that accurate? Building on Rob's question, what do you have included in your '19 plan? Are there any significant differences in period expenses outside of R&D that you anticipate for next year that we should take into account? Could you help us quantify how to approach that?

Yes. I mean, I would say outside of R&D, we definitely got some investments around productivity and systems that we're making again, thinking about kind of long-term competitiveness. So we've got some money put aside there and budgeted for the year.

Does that help year-on-year?

Yes, so obviously, we will manage that extremely tight as we always do, but we got budgets in place there and clear initiatives in business cases to go drive that. They're at a little over and above what we were spending in 2018.

And your Unit 2 program, you got it, you’re right on it. I mean 737, but increase in 787, we had a block extension in the quarter that was a big driver of that units, sorry, that program margin increase.

I wanted to continue on the 787. And just to understand a little bit better, how you’re looking at this longer-term and in terms of cash margin improvement? I mean, at a point now where you don't have that many shades in the mix anymore, and then you're going to have more. And then, if I look at pricing, I wouldn't expect you to get a lot more from there. So can you talk about, as you look at the next few years, how you see that cash margin trajectory evolving and what's likely to drive it?

Yes, it's going to continue to grow. The team has done a great job executing our commitments and managing our rate breaks. I know I keep mentioning this, but we aren’t adding two derivatives while going up. They've performed extremely well while leveraging best practices. This will continue to play out. You're correct that we are bringing in more 10s since the mix currently is predominantly 9s, but the 10s are valuable. The advantages of this will become clearer over the long term from a cash perspective, especially with the rate increases. You will notice the cash flow associated with those advances and the higher rates. At the same time, we're reducing expenditures, and we should not overlook the step-down pricing in the supply chain, which will also contribute to this along with our own productivity. There are about six categories of factors that will play a role or will naturally progress as we move through each phase, leading to a better mix and ongoing reductions in supply chain costs. Overall, we anticipate growing cash flow from the 787. They have excelled in meeting their commitments to shareholders and customers, and now we’re transitioning to the next phase, moving up to 14 and continuing to realize productivity gains.

And then just on the -10, when you delivered, I think, nine of them in Q4. So would it be fair to say that your -10 margins were probably a little less mature in the quarter we just saw and you should get some improvement out of that as well. Is that clear?

To your point still relatively early in the production system and in the supply chain. So as that becomes more mature just like we would normally will come down that learning curve as the supply chain will and we will capture the benefits of that.

To that, Doug, there is also big benefit from the high level of manufacturing commonality between the -10 and 9, which accelerates and reinforces what Greg said. And then the value proposition for that airplane in the market with our customers is very clear that it's generating value and its winning in the marketplace on the pricing side. It's holding up well there as well just because of the value it's creating for our customers.

So you mentioned the idea of, I think, trying to bolster the backlog for 777 and 777x. And you talked a lot in the past about wide-body replacement orders coming in the early part of the next decade. Does that mean in the near-term, are there 777x order opportunities or fewer opportunities in the near-term kind of focus on more of the classic and freighters, and we are we kind wait until we get into the early part of the next decade to see the orders for the 777X come through?

Seth, we’re working both in parallel. Certainly during the last year we've seen some great progress on the 777 with the 51 net orders in the year. And that's really strengthens that the bridge that we’re building 777 to 777X. We still have some work to do to fill out the remainder of the bridge, but our confidence continues to grow in our ability to do that. And as we've made that progress, we are now shifting our teams more and more to 777X opportunities. As you said, we do see a high wave of replacement demand early in the next decade. But that means those sales campaigns are underway now. So those are very active, we’re engaged with a number of customers around the world. The 777X clearly is bringing a value proposition as the market gets attractive. And you'll see us focusing more and more on those 777X campaigns here during this coming year. So that's a very near-term effort as well. And all of that is consistent with the investment profile and the production system ramp and transition that we talked about earlier.

In the free cash flow walk that you provided, you highlighted the headwinds from 777x in 2019. Could you maybe talk about whether 2019 is going to be the peak year for 777x investment, I’m thinking mainly working capital? And how many airplanes do you plan on kind of having in flow before you actually start making deliveries?

Yes. The profile, David, certainly for the reasons you described building the inventory and the test aircraft and so on. So this year there is more headwind. And then as we move into 2020, that headwind will moderate. And so we will start to have some more positive cash flow with the combination of 777X moving into production and then into delivery. So this is kind of a peak year for us on, I will say, cash usage on 777 combined with 777X. So as Dennis said, transitioning the airplane today in the factory and moving through building up that move from development to production will be key, and obviously, a big driver on the cash flow and things are going well out there today. So we got very good early signs that the aircraft is moving into production system smoothly and any challenges we're having, we’re working through we know what they are, but so far so good. So that'll be a big driver of cash flow going forward.

And did I hear you say that 777 deliveries in 2020 would actually step up a bit is that just the legacy kind of 777 rate holding and 777X starting to deliver?

It's really a combination of the two aircraft, the X and the 777. We are still seeing strong demand for the 777, especially in freight. We are integrating our strategies to ensure we meet customer demands in the near-term while also introducing the 777X. This is a crucial focus for 2020. However, we are not seeing robust demand for the 777. The production rates for these two programs will be combined.

Yes. Just for clarity, 2020, production system will be operating in five months, when we look at that delivery rate, slightly increasing over the current 3.5 months delivery rate, that's the combination of 777 and 777X, as Greg mentioned.

Going back to commercial profitability just because this is such a standout, how sustainable is the 100 bps of margin improvement? Are there any mix impacts we should be thinking about with the 777 coming in with these changing customer dynamics for any pricing dynamics that would alter that trajectory?

You're thinking kind of beyond '19?

Yes.

Well, I mean, there is a lot of moving pieces. Obviously, when you get into '19, we're more stable at 14 a month and we're more stable at the 57. So again, we should be able to capture productivity and we're expecting to capture productivity in that. And there are some mix movements certainly between the 777 ramping down and the X moving in. So there's a lot of moving pieces, but I think, Sheila, and I will let Dennis comment here. But the objective we have in place is the same one as I address in the prior question. We’re looking for opportunities where we can derisk production system and bringing in automation where we can bring in automation and bring in best practices with an overall objective to grow margins and fund our future and return cash to shareholders. So that's playbook. You should just think of that as the same no matter what the mix. So we don’t let mix be the deciding factor. Mix is mix. It's our job to try to offset that or use that to our advantage the best way possible.

Yes, and just to reinforce that Sheila, as Greg said, a lot of moving parts here, but the sustained margin growth trends is one that's long-term. So we expect to continue to see year-over-year margin growth in 2019 and further growth in 2020 and beyond. So this is all about long-term sustained top and bottom-line growth. And the gain book that we're operating here will drive that year-over-year.

Let's think about the NMA for a second. I don’t want to mid pick little bit, but again, as you just mentioned that NMA was going to be a two-step decision process with the final decision coming in '20. Are you saying that you would make the announcement for the public so to speak in '20 after talking your customers in '19? So if you could just clarify that announcement. And then the second part of the NMA question is how are these conversations going with your customers around this plane being used as a replacement aircraft versus opening up new market maybe relative to new designs in the past? Thanks.

Yes, Hunter, I can address the first part. The decision-making process we are discussing is the same as in our previous programs. This year's decision is referred to as the authority to offer, which is based on a business case and our ability to engage in detailed discussions with customers. This will be publicly announced once we reach a decision. That announcement will trigger in-depth and significant conversations with our customers. Based on market feedback and our capacity to assemble the right group of launch customers, we will then make the official launch decision next year. Both of these steps typically involve public announcements that you will notice. I want to stress the thorough approach we are applying not only to the aircraft decisions but also to the enterprise transformation goals we have regarding our future production system. We regard this as a comprehensive enterprise initiative, being very disciplined in our business case analysis. Now, what was your second question, Hunter?

Yes, it was sort of just how the conversation is going through your customers preliminarily at least around this plane being used as sort of an enabler of opening up new point-to-point markets versus replacement relative to say really I was thinking about 787 specifically, but just broader in general. Thanks.

We have engaged extensively with more than 60 customers and received consistent feedback. There are various market segments and potential applications for this airplane. We have identified a market need that exists between the current narrow-body and wide-body families, which cannot be addressed by modifying existing platforms and aircraft. Some of this pertains to medium-haul segments that are currently served inefficiently by wide-body aircraft, presenting an opportunity for airline customers to enhance their efficiency. Additionally, there is the potential to establish new medium-range route structures. Similar to the introduction of the 787, which led to around 200 new city pairs emerging due to the aircraft's capabilities in the medium-range market, we see potential for significant growth in regional city pairs with this airplane. We have received notable customer interest across multiple segments. Our primary focus is to develop a business case that generates value for our customers, our company, and our shareholders, which is the work that remains to be completed.

Just a question, and maybe a follow-up. How do we think about the 900 airplanes like where do you have to transition 737 and 787 to get to 900? That’s a lot of airplanes. Total make 75 a month right on average?

Yes, Ron, you've made the right calculation here. So as I mentioned, we’re well into the 14 a month rate step on 787, and we expect to complete that transition in the second quarter. So that's moving forward very briskly and on track. On the 737, we've already moved parts of the supply chain to 57 a month. But we still have some work to do on some elements of the supply chain, in particular with engines and CFM. And we’re not going to make that full transition of 57 a month. And so we’re very confident that we're ready. And it's important that we do that in a very disciplined way. So you can back into the number mathematically, with about 900 deliveries for the year note that 900 roughly deliveries for the year also includes the military derivative. So P8 tankers are all included in that number, just for clarity.

It's one of the parameters that we think through anytime we're thinking about investments for the future. We realize earlier we fundamentally have changed our R&D investment strategy for the companies that it's feathered over the long term where we can sequence development programs so that we gain the benefits of continuous development and lessons learned program-to-program rather than stacking multiple development programs on top of each other. And that’s the way we’re thinking through NMA as well. So not only the development programs or that particular airplane in the market it will serve, but also how do we sequence it, how do we leverage learning’s from 777X, how do we leverage what we're learning from things like T-X and roll that into NMA, and then how could we use an NMA investment to think about leverage and creating the production system for even more distinct future whether that be some future narrow-body airplane or other alternatives that we might invest in. But think of this as a continuum of R&D effort. This again is all key to creating a sustained growth business where top and bottom line of both long-term sustained growth levels. That is our approach here. And so we’re thinking about NMA in that multi-program context.

Got you. Can I ask one more at the tail end here?

I think we're …

Can I ask just sort of a quick one? Just for Greg. Greg, when we think about the 727 engine versus the MAX, just for modeling purposes, it's going to be approximately 90% MAXs this year. How do we think about the margin profile of one variant versus the other?

Well, it's still kind of early introduction, right. So you take that into account, but net-net, you’re in a similar margin profile as you're on NG. It's really just more around on timing from a unit perspective. It's how they are feathered in. So I wouldn't think of it any different. It's really just again more timing.

Okay. So operator, we have time for just one more analyst question.

Hey, Dennis, just maybe an easier one on book to bill expectations in 2019, I guess, specifically around 737 MAX orders, you mentioned you had 13 new customers in 2018 and you had, really I think 5,000 aircraft since the launch. So that’s close to 68%, I think, of the covers of NGs. Just how you are thinking about the order momentum with that program? Thanks.

Peter, we continue to see strong order momentum there I think just another sign of it this week earlier you saw ANA's announcement about their intent to buy the MAX. And that’s another addition to fleet there. So we see continued momentum on the MAX sales front. That airplane is creating value in the market for our customers. And we are oversold against our production profile. We talked earlier about ramping up to 57 a month. We are oversold against that profile. We're filling skyline slots way out in 2023. We continue to see upward market pressure overall on the production rate as a result. And we think the demand for that airplane continues to be sustained. So while we have great order volume and momentum this year. And I mentioned we might see some moderation in that demand this coming year. We still expect book to bill to be in that one-to-one range, and there is always timing variability. But in terms of the MAX, the demand signals in the marketplace continue to be very strong.

Thank you. We will continue the call with media questions for Dennis and Greg. And if you have additional queries following this session, please call our Media Relations team at (312) 544-2002. Operator, we are ready for that first question. And in the interest of time, we ask that you limit everyone to one question please.

Some other manufacturers have reported seeing economic weakness in China, the major headwinds. What are you all seeing? And are the orders from China setting lines picking up and overall? Where do you expect to see that moderating order intake coming from around the world? And where is either demand slowing a bit or growth slowing a bit from what you all see?

Yes, Andrew, let me touch on the China question first. We continue to see strong demand in China overall in terms of market dynamics. As I said earlier, over the years, we see a world that needs about 43,000 new Commercial Airplanes. We remain very confident in that outlook and about 7,700 of those 43,000 are in China. And that remains solid traffic patterns in China continue to progress. We're seeing passenger growth there that exceeds the overall market growth around the world and we also see passenger traffic growth there continuing to exceed GDP growth. So those market fundamentals remain strongly in place. In terms of our orders volume in China that's typically paced by timing of their five-year planning. So it tends to come in waves. So that’s why we, again, as we look to the future we expect to see some timing adjustments on orders, but overall volume over the long-term remains very strong. And that really applies to my broader comment to about moderation of orders in 2019. As we look to the long-term the market fundamentals are very strong. And we see long-term volume of orders continuing to grow and adding backlog. It just gets into a question of local timing quarter-to-quarter and year-to-year as our customers meet their fleet needs. So nothing here that I would say is a macro trend or substantial change. We just see fundamental aerospace growth and air traffic growth as a long-term sustainable trend. And with the backlog of about 5,900 aircraft to roughly seven years of production, that gives us the ability to weather any local variations and maintain a long-term view in terms of sustained growth.

If I just wanted to ensure that I understood your point about China, Dennis, do you anticipate a dip in orders this year due to the upcoming five-year plan? Additionally, I have a completely unrelated question. Where does CFM stand on its plan to catch up with the LEAP? How common is it for Boeing to integrate your personnel into their supply chain?

Julie, on your first question regarding China that was exactly my point earlier, given the five-year planning cycle there, we are having ongoing discussions with our customers in China, the Chinese government, the U.S. government. This also factors into the trade dialogue between the U.S. and China. But these are all factors that we’re very much engaged in. Again, we expect China as a long-term growth market for us. But exactly how those efforts play out over the next quarter or two is still an open question as we proceed with trade discussions. I can tell you having been intimately involved in the discussions and engagement with the governments both U.S. and China, we see our progress on that front and we see convergence. And we also see that there is clearly a mutual benefit of having a healthy aerospace industry for both the U.S. and China. China needs the airplanes for growth to fuel their economy and to meet their passenger growth and cargo growth needs. And here in the U.S., our aerospace business is a tremendous U.S. jobs generator, manufacturing jobs. We hired 34,000 people last year. And we, as an aerospace industry here in the U.S., create about an $80 billion a year trade surplus for the country. So there is mutual interest, and I hope the aerospace business. We expect that to lead the reproductive-pre-discussions between the U.S. and China or at least be part of that. And then that will factor into the ultimate orders volume and timing with China. That's just a little additional context there. Regarding your CFM question, it's not unusual for us to have Boeing personnel at our suppliers' sites and down into their supply chain. That's a very typical process that we would have. But I will say again as it goes 737, one of the supply chain health issues that we're spending a lot of time on right now is engines and our work with CFL. And so we’re deploying additional resources with them into their factories and supply chain. Now we do expect to recover. We’re seeing signs of recovery. But we still have work to go. And being deeply engaged in our supply chain is part of how we do business.

I had the China question which was one of my main ones. Can I just ask you about Brexit then? I know you’re in a very different position to Airbus here in the UK. But I just wondered whether you see any risk to your operations in the UK in the event of hard Brexit just a few weeks ago before the 29th of March.

Silvia, we are closely monitoring the situation, as you can imagine. We are deeply engaged in discussions, and we remain committed to our operations in the UK. Over the past several years, we have significantly ramped up our presence, roughly doubling the size of our operations and tripling our supply chain in the UK, which are long-term investments. We do not anticipate changes due to the outcome of Brexit but are vigilant to ensure it does not impact our operations. As a further demonstration of our commitment to the UK, we opened a new operation in Sheffield last year where we are engaged in advanced manufacturing. This also supports the development of our actuation vertical capability, showcasing our long-term dedication and ongoing investments in the UK.

Okay. Operator, we have time for one last question from the media.

As I’m going back to the 737 MAX situation and CFM, in December with the delivery of 69 airplanes, it did seem like you have almost fully recovered. Has there been some further setback? And is the need to send people to CFM, is that because there's a problem with the ramp-up of the engine production? Or is there some configuration change that’s become necessary? Can you just tell us a bit more? Also what's the timeline you expect to be back to normal, let's say?

Yes, Dominic, first of all, as you saw in our December deliveries, as you alluded to, we did see some recovery across our supply chain, including engine supply and that enabled us to drive those December deliveries of 69 aircraft. But we were not yet fully recovered at that point, so we've continued to work supply chain recovery and there still work to go there. There is nothing here that I would say is an issue associated with having to change configuration or make that kind of alteration to the engine. This is really about just ramping up production and doing it efficiently and being able to get a liner profile engine deliveries that matches up with our factory production rate for the airplane and synchronizing those production systems. That's really what we're focused on. We still have work to go to get CFM to be supporting our 52 a month production rate and having those systems synchronized, and then even more work to go yet to get them ramped up to 57 a month. And that's really what we're focused on. This is about production system ramp-up and synchronization. And by us getting deeper into the factories, it's going to give us better insight on long lead items. And, frankly though, I think help us do best practice sharing between Boeing and CFM, which is part of how we operate, right. That will make us better and it will make CFM better. And that work that we plan to be very focused on in the first quarter and timing of that is reflected in our overall delivery guidance for the year. So you can see that factored in. But we're going to be very, very disciplined about ensuring supply chain health before we fully move to the 57 a month production rate.

Okay. That concludes our earnings call. Again, for members of the media, if you have further questions, please call our team at (312) 544-2002. Thank you.