Boeing Co. (NYSE: BA) filed its 2016 Form 10-K annual report with the U.S. Securities and Exchange Commission (SEC) on Thursday. Like nearly all required filings for every company, the Boeing 10-K contains a range of detailed information that is often not included in quarterly press announcements or even quarterly SEC filings.
We’ve read through the Boeing 10-K with an eye to finding some of those details that investors might not find in other documents. We paid special attention to the section of the 10-K related to risk factors.
Here are some things we found that may not be on investors’ radar. Italic text indicates a direct quote from the filing.
We enter into firm fixed-price aircraft sales contracts with indexed price escalation clauses which could subject us to losses if we have cost overruns or if increases in our costs exceed the applicable escalation rate.
Boeing’s defense systems segment generated approximately 71% of 2016 revenues from fixed-price contracts. Cost-overruns (what Boeing calls reach-forward losses) totaled $1.13 billion last year on the KC-46A tanker fixed-price contract.
In 2016, 23% of our revenues were earned pursuant to U.S. government contracts, which include foreign military sales through the U.S. government. Business conducted pursuant to such contracts is subject to extensive procurement regulations and other unique risks.
In 2016, non-U.S. customers accounted for approximately 59% of our revenues. We expect that non-U.S. sales will continue to account for a significant portion of our revenues for the foreseeable future.
As of December 31, 2016 and 2015, our airplane financing commitments totaled $14,847 million and $16,283 million.
Boeing finances these commitments, in part, with debt. Rising interest rates will affect the company’s interest payments. Boeing paid $306 million in interest expense last year, an increase of more than 10% from 2015.
Approximately 57,000 employees, which constitute 38% of our total workforce, were union represented as of December 31, 2016.
Boeing currently has relationships with 11 U.S. unions and seven non-U.S. labor organizations. Union labor at the company’s suppliers may also affect the company’s ability to meet its commitments.
The decrease in contractual backlog during 2016 and 2015 was primarily due to deliveries in excess of net orders.
This is the company’s book-to-bill ratio expressed in dollars. Since the banner year of 2014, backlogs have been shrinking as new orders slow. Commercial contractual backlog at the end of 2016 is $416.2 billion, down from $440.12 billion in 2014 and $431.41 billion in 2015. Including the defense segment’s backlog, total contractual backlog for 2016 is $458.28 billion, down from $487.1 billion in 2014 and $476.6 billion in 2015.
Many of our non-U.S. customers finance purchases through the Export-Import Bank of the United States. Following the expiration of the bank’s charter on June 30, 2015, the bank’s charter was reauthorized in December 2015. The bank is now authorized through September 30, 2019. However, until the U.S. Senate confirms members sufficient to reconstitute a quorum of the bank’s board of directors, the bank will not be able to approve any transaction totaling more than $10 million.
Boeing may find itself in the position of having to fund additional commitments or entering into new financial arrangements with customers if the Ex-Im Bank doesn’t attain a quorum. This diverts liquidity from other places the company might prefer to use it.
Many competitors are expected to benefit from the strong U.S. dollar experienced in 2016 and ongoing improvements in efficiency, which may result in funding product development, gaining market share through pricing and/or improving earnings.
Boeing is not just worried about Airbus. Canada’s Bombardier has sold some CS100s and Brazil’s Embraer is also trying to move up from the sub-100 seat regional jet market with another model to compete with Boeing’s 737 and Airbus’s A320. Other competitors from China, Russia and Japan have also made moves in the single-aisle category, although first deliveries are still a few years in the future.
The 777X will have a separate program accounting quantity, which will be determined in the year of first airplane delivery, targeted for 2020.
The number of planes Boeing plans to produce for delivery under existing and anticipated contracts is called an accounting quantity, or sometimes an accounting block. The 787 has an accounting block of 1,300 aircraft and the current 777’s accounting block was lowered from 1,650 in 2015 to 1,625 in 2016. Boeing produced the 777 at a rate of 8.3 per month in 2016, but that drops to seven per month early this year and will drop further to five per month in the second half of 2017. Boeing has taken orders for 306 new model 777-9s (part of the 777X family), not including an order announced Thursday from Singapore Airlines for 20 more of the planes.
In a related development, CEO Dennis Muilenburg said Thursday that Boeing’s deferral requests from customers currently stands at 2%, well below the historical rate of about 6%. A low level of these requests offers Boeing the flexibility to adjust its manufacturing plans. But Muilenburg does consider the bridge between the 777 and the new 777X a “risk,” saying the company still needs to fill out the bridge, which is full this year, but only 90% sold for the next two years according to Leeham News.
[Boeing Capital Corporation]’s gross customer financing and investment portfolio at December 31, 2016 totaled $4,115 million. A substantial portion of BCC’s portfolio is related to customers that we believe have less than investment-grade credit. BCC’s portfolio is also concentrated by varying degrees across Boeing aircraft product types, most notably 717 and 747-8 aircraft.
Boeing built its last 717 in 2005, and it only built a total of 155 of the 100-seat planes. But there is a thriving market for used 717s. The company owns 103 of the planes and leases them out to various airlines. At the end of December 2016, BCC had $6 million in assets held for sale and re-lease, compared with $49 million at the end of 2015. Planes with a carrying value of approximately $46 million are coming off leases in 2017, and Boeing will either try to sell or extend the leases on these aircraft.
Aircraft values and lease rates are impacted by the number and type of aircraft that are currently out of service. Approximately 2,200 western-built commercial jet aircraft (8.8% of current world fleet) were parked at the end of 2016, including both in-production and out-of-production aircraft types. Of these parked aircraft, approximately 7% are not expected to return to service. At the end of 2015 and 2014, 9.5% and 9.8% of the western-built commercial jet aircraft were parked. Aircraft valuations could decline if significant numbers of additional aircraft, particularly types with relatively few operators, are placed out of service.
The number of aircraft coming off lease affects the market for new airplanes in the same way that cars coming off lease affect the market for new cars: the more newish planes available, the lower the demand for new planes. A big part of this market is driven by maintenance services, a market that Boeing is trying hard to enter. The company hired a new CEO away from GE Aviation for its services division recently in an effort to unify its services offerings and grow revenues by three times over the next five years.
Of the $4,211 [million] in gross customer financing, $2,760 [million] related to customers we believe have less than investment-grade credit including Volga Dnepr Affiliates, Silk Way Airlines and American Airlines who were associated with 18%, 9% and 6%, respectively, of our financing portfolio. Financing for aircraft is collateralized by security in the related asset and in some instances security in other assets as well.
Volga Dnepr placed an order for 20 Boeing 747 freighters last summer, but the order still does not show up on Boeing’s order book. Silk Way has taken delivery of four of five 747 freighters and American’s undelivered orders total 137, including 118 737s and 19 787s. While none of these is huge threat to the company’s performance if they go bad, they would at least be inconvenient.
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