Given the high profile nature of Boeing’s ongoing saga with the grounding of its 737 MAX aircraft, perhaps it should come as no surprise that the Securities Exchange Commission (SEC) Staff was particularly focused on the company’s disclosure of this issue in its recent review of Boeing’s SEC filings.
In monitoring SEC comment letters, we came across this SEC comment letter exchange with Boeing made public this week where the Staff questions the company about its commitments and contingencies footnote disclosures as required by Accounting Standards Codification (ASC) 450 – Contingencies.
Staff Requests More Disclosures in Contingency Footnote
In its Form 10-Q for the quarterly period ended June 30, 2019, Boeing discloses that it recorded in the second quarter an earnings charge of $5.6 billion, net of insurance recoveries of $500 million, in connection with “estimated potential concessions and other considerations to customers for disruptions related to the 737 MAX grounding and associated delivery delays.”
Boeing also stated the following in its Form 10-Q footnote:
“We are unable at this time to reasonably estimate potential future additional financial impacts or a range of loss, if any, due to continued uncertainties related to the timing and conditions of return to service, future changes to the production rate, supply chain impacts or the results of negotiations with particular customers. Any such impacts, including any changes in our estimates, could have a material adverse effect on our financial position, results of operations, and/or cash flows.”
In its comment, the Staff requested additional disclosure of these “potential future additional financial impacts.”
[Note: Per ASC 450-20-50, even after a company has recorded a loss accrual, disclosure of the contingency must be made if there is at least a reasonable possibility that an additional loss may be incurred. The disclosure must include both (1) the nature of the contingency, and (2) an estimate of the possible loss or range of loss or a statement that such an estimate cannot be made.]
Boeing Refers Staff to MD&A Disclosures on 737 MAX Grounding Impacts
Among other things, Boeing’s response refers the Staff to the company’s MD&A, which has a more thorough discussion of the financial statement impacts of the 737 MAX grounding. It makes sense that the MD&A would have this enhanced discussion because Item 303 of Regulation S-K requires disclosure of unusual events or changes that materially affected results of operations as well as known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on financial results.
After citing some of these MD&A disclosures in its response, Boeing states, “We believe that readers of our Form 10-Q would correctly infer from our disclosures that all of the unfavorable year over year revenues, operating earnings, and cash flow variances […] are attributable to the lack of 737 MAX deliveries and/or potential concessions and other considerations.”
In addition, Boeing states in its response, “We do not believe providing more granular detail quantifying how much 737 revenues, operating profits, and cash flows are down versus the prior year would provide new material insight to investors.”
However, in an effort to respond to the Staff’s comment, Boeing commits to add some additional discussion in the contingency footnote of impacts related to the 737 MAX grounding that are material to the company, as well as those impacts which it expects to become material in the event that its ability to resume aircraft deliveries is delayed beyond its current assumption.
What About Cross-Referencing from the Contingency Footnote to the MD&A?
After seeing this comment letter exchange, one might naturally think another option for Boeing was to simply include a cross-reference in the ASC 450 contingency footnote to the more robust discussion of these issues in the MD&A. Unfortunately, such a cross-reference is no longer permitted as a result of recent FAST Act changes.
Included among the SEC rule updates made earlier this year were amendments to Rule 411 (under the ’33 Act) and Rule 12b-23 (under the ’34 Act) to prohibit companies from incorporating by reference in their financial statements, or cross-referencing in their financial statements, information outside of the financial statements unless otherwise specifically permitted or required by the SEC’s rules or by U.S. GAAP or IFRS, whichever is applicable.
As stated in the SEC’s adopting release, the purpose was to “reduce potential confusion and make it less cumbersome for investors to determine what pieces of financial information form a set of audited or reviewed financial statements.” Therefore, Boeing was left with ensuring that its required ASC 450 disclosures were self-contained in the financial statement footnotes.
Read the Relevant SEC Staff Comment and Boeing’s Response
Form 10-Q for the Quarterly Period Ended June 30, 2019
Note 11 – Commitments and Contingencies
737 MAX Grounding, page 15
We note from your disclosure here that, while you have suspended deliveries of the 737 MAX during the grounding, you have continued production at a reduced rate. You have disclosed here that the resulting impacts, which were reflected in the first quarter, increased costs to produce aircraft included in the current accounting quantity by $1,748 and reduced 737 program and overall BCA segment margins. We also note your disclosure on page 16 that the grounding has reduced revenues, operating earnings and cash flows during the first quarter of 2019 and will continue to adversely affect results until deliveries resume and production rates increase, you are unable at this time to reasonably estimate potential additional financial impacts or a range of loss, beyond the $5.6 billion charge to earnings because any such estimate would depend on many factors, including the ongoing status of the accident investigations and the timing and conditions surrounding a return to service. Please explain to us in detail or revise to quantify the additional impact to revenues, operating earnings, and cash flows during the income statement periods presented especially resulting from non-delivery at this stage.
The financial statements included in our Form 10-Q for the quarter ended June 30, 2019 reflect the $5.6 billion reduction in revenue related to estimated customer concessions and other considerations, net of insurance recoveries. We have not recognized any revenue or profit related to 737 MAX since the suspension of 737 MAX deliveries on March 13, 2019. The MD&A section of the Form 10-Q describes the impact of the absence of 737 MAX deliveries on revenue and operating earnings, and the impacts of the 737 MAX grounding on cash flows in the form of higher inventory, the lack of delivery payments, and lower advances and progress billings. Page 15 of our Form 10-Q also includes disclosure to the effect that impacts associated with the 737 MAX software updates and related pilot training were immaterial. Finally, we disclosed that increased costs of $1,748 million across the 737 accounting quantity will reduce the 737 program and overall BCA operating margins in future quarters after deliveries resume. To date, as discussed in the response to the Staff’s Comment 4, the 737 MAX grounding has not resulted in significant order cancellations. However, new 737 MAX orders are lower than during the quarters immediately prior to the grounding, which we have disclosed.
The following excerpts from our MD&A highlight how we have addressed the impacts on revenues, operating earnings and cash flows of the lower deliveries as a result of the 737 MAX grounding.
Commercial Airplanes Revenues for the six and three months ended June 30, 2019 decreased by $10,353 million and $9,230 million compared with the same periods in 2018 driven by lower deliveries and a revenue reduction of $5,610 million that was recorded in the second quarter of 2019 related to estimated potential concessions and other considerations to customers for disruptions and associated delivery delays related to the 737 MAX grounding. The 737 MAX grounding will continue to have a significant impact on revenues until deliveries resume. (page 41)
Commercial Airplanes Earnings from operations for the six and three months ended June 30, 2019 decreased by $6,970 million and $6,731 million compared with the same periods in 2018 primarily due to the earnings charge for the 737 MAX grounding of $5,610 million and lower 737 deliveries, partially offset by higher 787 margins. The 737 MAX grounding will continue to adversely impact margins until deliveries resume. (page 42)
Boeing’s Net cash provided by operating activities was $2.2 billion during the six months ended June 30, 2019, compared with $7.8 billion during the same period in 2018. The net loss from operations for the six months ended June 30, 2019 was primarily driven by the $5.6 billion charge for estimated potential concessions and other considerations to 737 MAX customers and did not affect cash flows. The decrease reflects higher spending on inventory and lower growth in advances compared with the prior period. Inventories increased by $5.9 billion during the six months ended June 30, 2019 primarily due to the suspension of 737 MAX deliveries, which resulted in higher commercial airplane program inventory as we continue to produce 737 MAX aircraft at a rate of 42 per month. Advances and progress billings increased by $1.8 billion and $2.9 billion during the six months ended June 30, 2019 and 2018. Net cash provided by operating activities in future quarters is expected to be adversely impacted by the 737 MAX grounding. (page 49)
We believe that readers of our Form 10-Q would correctly infer from our disclosures that all of the unfavorable year over year revenues, operating earnings, and cash flow variances excerpted above are attributable to the lack of 737 MAX deliveries and/or potential concessions and other considerations. As such, readers would understand the significance of the 737 MAX grounding and its very material financial impacts on our revenues, operating earnings, and operating cash flows. We do not believe that providing more granular detail quantifying how much 737 revenues, operating profits, and cash flows are down versus the prior year would provide new material insights to investors.
Further, we believe that the current situation is temporary and timing and conditions surrounding return to service will continue to have the most significant financial impact on our financial statements in the near term. We expect that, in the event that we are unable to resume aircraft deliveries consistent with our assumptions, the continued absence of revenue, earnings, and cash flows associated with 737 MAX deliveries would continue to have the most significant impact on our operating results. In the event that we decide to further reduce the 737 production rate or temporarily cease production, we expect that the growth in inventory and other cash flow impacts associated with production would decrease. However, while any such reduction or cessation of production could mitigate the impact of continued production on our liquidity, it could significantly increase the overall expected costs to produce aircraft included in the accounting quantity, which would reduce 737 program margins in the future.
If you have questions about this or other issues related to contingency disclosures, please contact any member of our Corporate & Securities Practice for more information.
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