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Thursday, July 27, 2006 - Page updated at 12:00 AM

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Delays, fines stain Boeing bottom line

Seattle Times aerospace reporter

Paying for past scandals and program failures while ramping up spending on its new 787 jet, Boeing lost money last quarter. But management raised revenue and profit forecasts for 2007, citing a strong underlying business.

Despite a roaring commercial-airplane business, two big accounting charges totaling more than $1 billion sent the plane maker and defense contractor into the red.

Bowing to political realities and seeking to enhance Boeing's reputation on Capitol Hill, Chairman and Chief Executive Jim McNerney said in a teleconference with financial analysts that Boeing will not seek a tax deduction on the largest charge, a $615 million fine to settle past ethics scandals with the U.S. government.

Forgoing a tax deduction was, he said, "the right thing for Boeing to do" so that the company can "focus on the future and put this unfortunate part of our past behind us."

It may also have been the smart thing to do politically, since leading lawmakers had served notice they would question McNerney on the subject.

The other big charge, for $496 million, was for lost revenue and contract penalties over delays on delivering airborne-surveillance aircraft to Turkey and Australia.

Boeing lost $160 million in the second quarter ended June 30, compared with a profit of $566 million a year ago. It's the company's first quarterly loss since the third quarter of 2003.

Reviewing the state of the company's businesses, McNerney revealed Boeing could face a future accounting charge of up to $350 million for sale or closure of its ailing Connexion in-flight Internet business.

That news and the planned increases in 787 research-and-development spending sent the stock down $3.85, or 4.6 percent, to $79.90.

Paying for scandal

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"A few years ago, certain Boeing employees did some things that were wrong," McNerney said, explaining reasons for the ethics-scandal settlement.

He said Boeing had to accept responsibility for the actions of those employees, and agreed to pay $565 million in civil penalties and $50 million in criminal fines.

One of the two major scandals centered on Boeing's hiring of former Air Force procurement official Darleen Druyun, who favored Boeing in several contracts worth billions of dollars. The other involved midlevel employees stealing proprietary Lockheed Martin rocket-contract pricing data.

Boeing's lawyers believed the settlement fine was tax-deductible, which Sen. Chuck Grassley, R-Iowa, estimated could have saved the company up to 35 percent of the civil penalties, or nearly $200 million.

But applying for the tax relief proved too contentious a political issue.

Senators object

In a June 29 letter to U.S. Attorney General Alberto Gonzales, Grassley and Sens. John McCain, R-Ariz., and John Warner, R-Va., objected to the prospect of taxpayers subsidizing Boeing misconduct.

"We have been advised that the bulk of the settlement is, in fact, tax-deductible," McNerney said. "The short-term financial impact of the taxability issue is significant. However, the long-term value of Boeing's reputation is even more significant."

The decision should make it much easier for McNerney when he testifies before Warner's Senate Armed Services Committee at a hearing Tuesday on the settlement.

Grassley welcomed Boeing's move Wednesday. "That's the right decision," he said in a statement.

McNerney said Boeing is significantly boosting research-and-development spending on the 787. It has spent $1.5 billion in total R&D in the first six months of this year, two-thirds of that in the commercial-airplane division, compared with just over $1 billion in the first half of 2005.

Boeing management expects total company R&D expenses to be $3 billion, both this year and next.

More engineers, overtime

McNerney said the money is going into "more engineers and more overtime" to ensure Boeing can meet 787 program goals on airplane weight and delivery schedule.

Still, he insisted these issues are "more normal than abnormal" on a new airplane program and said the 787 will still be "the most efficiently developed airplane that we've ever done."

McNerney admitted that some of Boeing's partners had run into trouble, though nothing "unanticipated or earth-shaking."

"We've had a couple of instances where we've moved work," he said, "but that was all part of the contingency plan where we had built extra engineering capacity in the event that someone ran into an issue.

"We're attacking the weight issues aggressively and the associated schedule issues," McNerney said. "We still see the plane delivered on time, within the performance commitments we've made to our customers."

The 787 is due to fly in the third quarter of 2007 and to enter service in May 2008.

"There are always going to be issues, and we're paranoid every day about them," McNerney said. "I'd rather be paranoid now than deeply disappointed later."

Byron Callan, a leading financial analyst with Prudential Equity Group, characterized the R&D spending boost as "an alarm bell" but kept his "buy" recommendation on Boeing stock.

"No one should think that developing a new jet is a walk in the park," Callan wrote to clients after Boeing's results.

He said shareholders should focus on the strong demand for the 787 and its healthy competitive position.

Bullish on future

Despite all the charges this quarter and what McNerney called "very aggressive pricing" from rival Airbus, Boeing executives remain bullish.

Citing the strength of the commercial-airplane business and improvements in productivity companywide, Boeing raised its 2007 earnings-per-share forecast 15 cents to between $4.25 and $4.45 a share.

It increased its revenue forecast for 2007 by $1 billion, to between $64.5 billion and $65.5 billion.

Dominic Gates: 206-464-2963 or dgates@seattletimes.com

Copyright © 2006 The Seattle Times Company

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