On two occasions, on January 27 and again today on April 28, Boeing’s Chief Financial Officer Greg Smith warned analysts of the need of taking a reach-forward loss on the 787. But even now, with Dreamliner production being hampered by quality issues, Boeing hasn’t taken this bold step. It shows one thing: Boeing is confident the 787 will become a moneymaker.
First a look at why the Dreamliner is in trouble right now. Boeing paused deliveries between October 14 last year and March 26, costing it important revenues in Q4 and again in the first quarter this year. The reason deliveries were paused is a quality issue on various composite fuselage sections.
“In August of 2019, we determined that there was an issue with shimming in a specific batch of aircraft that was produced in early 2019. At that time, after we discovered the issue, it was addressed in the production system. That issue, by itself, was not an immediate safety of flight issue”, a Boeing spokesperson tells Airinsight. The problem was first seen on the aft fuselage sections 47 (which includes the pressure bulkhead) and 48 (unpressurized and enveloping the horizontal tailplane). Software of a laser system misread the size of the shims, approving them even if they were of an incorrect size.
Skin flatness issue
Then there was another quality issue: “Subsequently, in August/September 2020, we discovered a second issue in the same area of the aft fuselage. There are very tight tolerances for the flatness of the fuselage skin inner-mold line, the inner surface. Anything greater than five thousand (0.005) of an inch is outside the engineering tolerance. This is comparable to the width of a human hair or a piece of paper. Related to the skin flatness, we found that there were some non-conformances and that on some aircraft skin flatness was found beyond engineering tolerances.”
“When that was identified, we also looked across our production system to understand if there would be other impacts to safety or quality. We went back because of the location of this skin flatness issue in the aft section. We went back to look at that earlier batch of airplanes produced in 2019 and identified eight airplanes that had both of these issues. Based on that determination, we recommended that those eight be put out of service.”
These eight aircraft, delivered to Singapore Airlines, United Airlines, Norwegian, Air Europa, Etihad, Air Canada, and ANA, were grounded and repaired. “Of those eight, seven have been returned to service after rework and the eight are not currently in service unrelated to the issue. While neither the shimming issue nor the skin flatness issue is a safety of flight issue on its own, the combination of the two issues in the same location in the aft body was determined to be a safety of flight issue. That’s why we recommended the removal of those eight planes from service until the repair.
FAA stepped in
It was then that the FAA stepped in and requested a thorough review of 787 production and quality control. Not only at Boeing, but it proactively reached out to suppliers Boeing South Carolina (sections 47 and 48), Leonardo (aft fuselage barrel 46 and mid-section 44), Kawasaki Heavy Industries (forward fuselage section 43), and Spirit AeroSystems (nose section 41).
At the same time, deliveries were paused from mid-October. Engineering analysis confirmed that there has been room for improvements, as Spirit CEO Thomas Gentile confirmed at the February investor’s call: “We have started some rework just so that they can resume deliveries sooner. And as we get all of the engineering analysis done, we’ll determine in the long term what type of rework is done.”
During the Q1-results webcast On May 5, Gentile said Spirit had taken a $29 million pretax forward loss on the 787, mainly caused by the engineering analysis and rework on section 41. “We identified some similar fit and finishing issues that they (Boeing) had identified on other sections of the aircraft. So the rework and forward loss are related to us doing rework on those units.”
Some 100 Dreamliners in inventory
Between October and later March, the 787-inventory grew to 100 aircraft, but on March 26, United Airlines was the first to take delivery of a Dreamliner again. Boeing will go “tail by tail” through the inventory and do rework, if necessary. That will take most of the year, CEO David Calhoun said on Wednesday during the first quarter analysts’ call. But probably even shorter, as experience is gained with each airframe that needs rework. In the last week of March, two 787s have been delivered again, with seven more in April, including the 1000th Dreamliner – to Air Lease Corporation and leased on to China Southern.
Significant progress has been made with the program review, Calhoun said, but it’s still unknown if the FAA will require additional checks and balances to get 787 production quality back to where it was before the issues showed up. In a written statement to Airinsight, the FAA said on May 4: “The FAA continues to monitor Boeing’s implementation of corrective actions to address shimming issues on the 787. The FAA will review and validate the corrective actions to ensure that all safety concerns have been addressed.”
No reach-forward loss made so far
While Greg Smith warned of a reach-forward loss on the 787 twice, like the $6.5 billion on the 777X in January as projected sales were revised down by 118 aircraft, Boeing hasn’t made a decision so far on the Dreamliner, neither taken a charge on the extra costs. The reason can be found in the 10-Q filing released on April 28. It says:
“At March 31, 2021, and December 31, 2020, commercial aircraft programs inventory included the following amounts related to the 787 program: deferred production costs of $14,803 and $14,976, $1,795 and $1,865 of supplier advances, and $1,857 and $1,863 of unamortized tooling and other non-recurring costs. On March 31, 2021, $11.557 billion of 787 deferred production costs, unamortized tooling, and other non-recurring costs are expected to be recovered from units included in the program accounting quantity that have firm orders, and $5,103 is expected to be recovered from units included in the program accounting quantity that represent expected future orders.”
Table showing the progress on the reduction of deferred production costs of the 787 until Q1 this year. (Boeing)
In other words: while the 787 has still huge deferred production costs, Boeing is confident that it can recapture them when it continues to sell Dreamliners in the future. Program accounting quantities are based on selling 1.500 aircraft. Of these, 442 are undelivered units under firm orders. Cumulative orders stand at 1.436, so the target is pretty much insight.
To reduce costs, Boeing decided last October to consolidate production to one site. This has everything to do with the effects of the pandemic on the 787 long-haul markets. “The aviation industry has been severely impacted by the pandemic with expectations that long-haul travel especially will take longer to recover”, the spokesperson says. “Related to the impact on our industry, we reduced the production rate to five per month. We did an objective review of market realities on the air travel industry as well as production scenarios and logistical considerations for the 787. We determined that the logistics and economics of two 787 lines at a rate of five airplanes per month are not sustainable. All 787 models can be produced in South Carolina, but the Dreamlifter is not able to carry the longer fuselage section of the 787-10.” Since March, North Charleston in South Carolina is the sole production site for the 787, with Everett, kept open for rework only. Closing down Everett hasn’t had a significant effect on program costs in Q1, but the effect should become evident longer tern.
China key to future success Dreamliner
The 10Q filing says: “The 787 has near breakeven gross margins due to the reductions in production rates and the reduction in the program accounting quantity driven by the impacts of Covid-19 on customer demand.”
However, the next line in the paragraph is a disclaimer and warning shot to which Greg Smith must have been hinting: “China is a significant market for the 787 program, and if the program is unable to obtain orders from China in future quarters, we may be required to adjust production rate assumptions. If we are required to further reduce the accounting quantity and/or production rates, experience further delivery delays, or experience other factors that could result in lower margins, the program could record a reach-forward loss in future periods.”
So despite being only 64 aircraft shy from its program accounting quantity from which it will become break-even, the Dreamliner still could end up with a reach-forward loss if projected sales campaigns in especially China fail. Which will for one thing depend on US-Chinese political relations. In February, Spirit said it expects to break even on the 787 from line number 1405. Production recently has arrived at line number 1120, so at reduced rates that will take a few more years to achieve.