The first Boeing 747-8 Intercontinental.

The first Boeing 747-8 Intercontinental.

Feds reportedly investigating Boeing’s 787, 747 accounting

  • By Robert Schmidt, Julie Johnsson and Matt Robinson Bloomberg News
  • Thursday, February 11, 2016 1:00pm
  • BusinessEverett

The Securities and Exchange Commission is investigating whether the Boeing Co. properly accounted for the costs and expected sales of two of its best-known jetliners, according to people with knowledge of the matter.

The probe centers on projections Boeing made about the long-term profitability for the 787 Dreamliner and the 747 jumbo aircraft, said one of the people, who asked not to be named because the investigation isn’t public. Both planes are among Boeing’s most iconic, renowned for the technological advancements as well as the development headaches they brought the company.

Underlying the SEC review is a financial reporting method known as “program accounting” that allows Boeing to spread the enormous up-front costs of manufacturing planes over many years. While the SEC has broadly blessed its use in the aerospace industry, critics have said the system can give too much leeway to smooth earnings and obscure potential losses.

“We typically do not comment on media inquiries of this nature,” Boeing spokesman Chaz Bickers said in an emailed statement. SEC spokesman John Nester declined to comment.

SEC enforcement officials have yet to reach any conclusions and could decide against bringing a case, said the people. The issues involved are complex, and there are few black-and-white rules governing how companies apply program accounting, one person said.

After the news broke, Boeing’s stock price plummeted as much as 11 percent in trading on Thursday, eventually closing down 6.8 percent at $108.42 per share. Stock prices for other aerospace companies took a hit, as well. However, most companies do not face the same questions about their accounting. Those that do use program accounting, such as Spirit Aerosystems and Triumph Group, are not carrying anything approaching Boeing’s nearly $30 billion deferred cost balance for the 787 program.

If the SEC acts against Boeing, it is unlikely to trickle down to other aerospace companies, RBC Capital analyst Rob Stallard said in a note to investors.

Program accounting has been around for decades. It was first championed by the aerospace industry to address the problem that companies’ biggest expenses are amassed up front, as they design planes and devise manufacturing processes. Costs typically fall as the assembly becomes more efficient, making it cheaper to build the later jets than the earlier ones.

The method, which is fully compliant with Generally Accepted Accounting Principles, lets companies average out the costs and anticipated profits over the duration of the “program” for a specific jet, a period that can last decades and encompass hundreds or even thousands of aircraft.

The expected costs and sales are estimates and they must be updated — and a loss recorded — when the program is determined to have reached a point where earnings won’t catch up to losses.

As part of the investigation, SEC enforcement attorneys are examining whether Boeing’s financial statements relied on sales forecasts that might be too optimistic, one person said. Another avenue of inquiry is whether Boeing’s estimates for declining production costs will come to fruition, the person said.

A whistleblower has given SEC officials internal documents and data about Boeing’s accounting, according to the people. The tipster first raised concerns with the regulator more than a year ago, one person said. SEC policy is to not reveal the identities of whistleblowers.

Over the years, a handful of aerospace analysts have questioned whether Boeing will be able to recoup its costs for both the 787 and the latest 747, both of which debuted far behind schedule in 2011. In general, the company has enjoyed a good reputation on Wall Street, earning billions of dollars in annual profits and winning buy recommendations from most researchers who follow the industry.

Boeing’s accounting projects that the company will eventually make money on the Dreamliner, despite already spending $28.5 billion on inventory and manufacturing. The forecast hinges on Boeing selling about 1,300 planes and assumes profits on its later deliveries will offset high costs stemming from early production snarls.

To do that, Boeing has to squeeze about $40 million from the cost of making each 787, according to analyst Richard Aboulafia, vice president of the Teal Group, a consulting firm in Fairfax, Virginia.

Many analysts expect Boeing will not make all that money back and will have to write off several billion dollars as a loss.

Boeing told investors during a January conference call that its Dreamliner expenses would plateau this year and then begin to decline as it speeds production.

“We still have work ahead of us on the 787,” Boeing Chief Executive Officer Dennis Muilenburg said on the call. He added that the company is “focused on solid day-to-day execution and risk reduction, while improving long-term productivity and cash flow.”

Some analysts are skeptical that margins will improve enough to offset money that Boeing has already poured into the 787. Credit Suisse Group analyst Robert Spingarn estimated the company may face a $7.5 billion shortfall on the jet, according to a December report.

Boeing’s outlook for the latest and largest version of its jumbo family, known as the 747-8, has also been questioned by some aerospace analysts.

Over the years, Boeing has recorded several accounting losses, totaling $2.6 billion, for the 747-8 program. The most recent was last month, when the company reported an after-tax loss of $569 million and announced it would halve its production to six jumbos a year.

Boeing’s current accounting estimates for the program’s profitability rely on it selling 35 more 747-8s.

Meeting those numbers could be a challenge. The company has only had 121 orders for the jet since 2005, and most of those sales came before the 2008 financial crisis. In addition, Boeing only netted two 747-8 sales over the previous two years. It ended up buying both planes itself as part of a lease-back deal with a Russian cargo company.

Boeing executives have said they are hopeful of a possible resurgence late this decade for the 747 freighter, whose size and cargo-loading capabilities are unmatched. The company’s other sales prospects for the 747 include replacements for the Air Force One aircraft that ferry U.S. presidents.

Jason Gursky, senior aerospace and defense analyst with Citigroup, isn’t as optimistic.

“We expect the line to fully close early next decade after the Air Force One replacement,” Gursky wrote in a Jan. 22 report. He said the 747 order book is “very weak.”

Having to work off enormous deferred production costs means Boeing will have much less cash for research and design to stay ahead in the market and compete with Airbus.

On Wednesday, Boeing Commercial Airplanes CEO Ray Conner said the company plans to cut jobs and trim other costs due to competition and pricing pressure from Airbus.

Herald writer Dan Catchpole contributed.

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