GLOBAL REPORT

PROPRIETARY

FOR OPPENHEIMER FUNDS | 10 SOURCES

SEPTEMBER 30, 2010

The Boeing Co. Further Dreamliner Delay Expected

U.S. and European sources said Boeings Dreamliner faces several other issues than just the Rolls-Royce engine problem, and most said its delivery would be further delayed.
One-half of sources expect problematic and heavy outsourcing to create further delays; stated oil leak issue accurate, botched testing phase aggravating problem All sources expect BA to stick with RR/ LNs Trent 1000, but several expect switch to package B
EXECUTIVE SUMMARY SOURCES & BACKGROUND 10 sources (6 in the U.S. and 4 in Europe), comprising 8 industry experts, 1 aircraft manufacturer and 1 potential buyer
INTERVIEWS Sept. 324 OBJECTIVE Gain insight into the cause of the August uncontained failure of a Trent 1000 engine being tested on the Boeing 787 Dreamliner, and assess whether this was a one-time incident or indicative of a systemic design problem that could directly cause additional delays in the airplanes delivery

COMPANIES: BA, FNC IM, GE, RR/ LN

Delivery of The Boeing Co.s 787 Dreamliner is expected to be further delayed, as seven of 10 sources do not expect it to be delivered during 1Q11, including three who said it would be delivered during 2Q11 or 3Q11; another said 3Q11 or 4Q11. Although reported problems with Rolls-Royce Group PLCs Trent 1000 oil system issue are perceived as accurate, nearly all sources said it is only one of several issues likely to cause further delay. Sources reported extended and failed service outsourcing, as well as botched testing procedures and an overly aggressive timeline for delivery as reasons for the additional delay. However, no source expects Boeing to drop Rolls-Royce out of the Dreamliner program or thinks it should do so, noting it will stick to the Trent 1000 engine but likely will upgrade it to package B or even package C.

Boeing is blowing smoke. Rolls-Royce is certainly part of the problem, but Boeing has to take some of the blame as well for other issues.
U.S. industry expert

Trent 1000 is One of Many Issues

Nine of 10 sources said the publicized cause of the uncontained failure of a Rolls-Royce Trent 1000 during a U.K. test in August a fault with the engines oil system is accurate. However, none said the engine issue was likely to necessitate a total rethinking of the planes electrical design. A European source said, For that type of accident, I dont see how the design of the plane could possibly play a role; its impossible. Its all about the engine; I think Boeing is clean here. Several said such issues are usual in the development process of a new engine. A U.S. source said, These are brand-new technologies. There are bound to be problems. However, while eight sources blamed the engines design for the uncontained failure of the engine, five also reported a botched testing process, which exacerbated the initial issue on the engine. There does appear to be a persistent [oil] leak problem, but it may have been exacerbated by the way the test was conducted. The engine was restarted more than 20 times, and its only supposed to be restarted twice. Somebody really screwed up conducting the test. It appears to have been a comedy of errors, a U.S. source said. Nine of 10 sources only partly agreed with Boeings public statement that Rolls-Royces engine delivery issues are to blame for the latest delay in the 787 delivery. A U.S. source said, Tests are supposed to turn up failures; its a normal thing. The alarming thing to me about the failures wasnt that they occurred; it was how Boeing responded to them: by becoming agitated and assigning blame. Theyve become an extremely ornery company. To me it indicates that the 787 is a troubled

BOEING LOST CONTROL OVER SUPPLIERS

See last page for Important Disclosures and Analyst Certification

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project. Another U.S. source said, Boeing is blowing smoke. Rolls-Royce is certainly part of the problem, but Boeing has to take some of the blame as well for other issues. Five of 10 sources said there were outsourcing issues with the Dreamliner (among which the horizontal stabilizers manufactured by Finmeccanica S.p.A.s Alenia Aeronautica, mentioned by four sources), four said there was botched testing, and three said Boeings delivery timeline was overly aggressive. A European source said, Contrary to what is usually done in the aviation industry, Boeing outsourced many tasks up to whole development sections, like the plane body to Italian Alenia, all the interior electronics of the cabin like the cable system, hydraulics and the air conditioning. [Too many] contractors and subcontractors are involved, and Boeing totally lost control over their suppliers. They wanted to proceed like they do in the auto industry, but it did not work out. A U.S. source said, Boeing has laid off many of their most seasoned engineers and test pilots in the past few years. By laying off so many seasoned employees, theyve lost the black art of understanding why a part is malfunctioning by just looking at it. Theyve also outsourced much more than they should have, and companies theyve outsourced to have outsourced again. Even if it were running smoothly, it would be cacophony. The complexity of the project is driving Boeing crazy, and the money is just getting burned right now. Its placing extreme financial strain on everyone involved. For this problem, the blame goes straight to the executives at Boeing. A European source said, The plane is nearly three years late already. At the time when Boeing realized the whole dimension of the problem, they tried to fix areas where the process could be sped up again. While a regular test phase for this kind of project is scheduled for 1215 months, Boeing tried to abbreviate it to nine months by using more planes and engines and more frequent tests, but it did not work out because the maintenance and repair in between [test flights] took much longer than previously expected.

[Too many] contractors and subcontractors are involved, and Boeing totally lost control over their suppliers. They wanted to proceed like they do in the auto industry, but it did not work out.
U.S. source

Delivery Expected Beyond 2Q11

Seven of 10 sources expect delivery of the 787 Dreamliner to take place later than February because of the many issues the plane is facing. Three of six U.S. sources expect delivery in 2Q11 or 3Q11, while another U.S. source expects it to take place in 3Q11 or 4Q11. One said, I wouldnt be surprised to see delivery in the second quarter, or perhaps even the third. However, I think there may be problems with the production ramp-up at that point. Another said, I dont expect the first delivery before the third or fourth quarter. The supplier involved has hired consultants to work 24/7 to find a solution, but Im expecting a significant delay. A European source said, In the best of scenarios for them, theyll do a disguised delivery: presenting the plane to the press on the due date, but then keeping the plane on the ground for X weeks for some false pretext, like cabin design. Two U.S. sources also expect the 747-8 to be delayed. The 747-8 is also going to be delayed, due to flutter problems, one said.

Boeing Expected to Stick with Rolls-Royce

All sources expect Boeing to continue using the Trent 1000 engine, because of the investments already made, their customers requests and lack of choice. A U.S. source said, For one thing, billions have been invested in this plane, on both sides of the Atlantic. Theyre not going to just walk away from that. Besides that, I think this is seen as a surmountable problem. This kind of problem is why testing occurs. The timing was just really inconvenient. Sources also said Boeing needed to be able to offer a Rolls-Royce engine on the 787 because many customers already have a Rolls-Royce fleet. A European source said, Boeing needs to be able to offer at least two

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motorizations for the plane because lots of customers have maintenance contracts with one of the engine manufacturers and not the others. Boeing would lose customers which have maintenance contracts with Rolls-Royce if they were to drop the Trent 1000. Besides, dropping Rolls-Royce would be like a gift for their lawyers. Most expect Boeing to stick with the Trent 1000 engine and work on upgrades. A U.S. source said, Ultimately, Boeing will continue to use a Rolls-Royce engine because thats what some of their customers demand. What Boeing will do is phase out package A relatively early and upgrade the engine to package B. Customers wont have a choice. Theres already talk of a package C. This report was researched and written by Birgit Heitfeld, with additional reporting by Brian Cooke and Sylvain Gavard for OTR Global LLC.

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PAGE 4 | ADDITIONAL QUOTES

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ON ENGINE ISSUES

The oil leak is very well known and documented. United States Rolls-Royce has an incredible and well-deserved reputation for quality. This has to be a huge embarrassment for them. Theyre lucky someone wasnt killed. United States Boeing has used Rolls-Royce as a scapegoat to conceal its own failures. Europe Basically, the whole plane including the engine is a new development. The engine has parts of the Trent 900 model used by the [European Aeronautic Defence and Space Company N.V.s] A340, but its a smaller power class. Fuel consumption has to be reduced by 15% compared to previous models, which requires practically new development. Europe I would expect Boeing to focus their production efforts on [General Electric Co.s] GEnx generation planes in order to satisfy those clients, and hand Rolls-Royce a bill for the costs associated with the Rolls-Royce engine delay. United States The GE next-generation engine has not faced such severe problems [as the Trent 1000s] yet. One has to consider that GE is way behind Rolls-Royce in the testing phase. They only work with planes 5 and 6 and have around 200 hours of flight documented, while Rolls-Royce has completed 1,500 hours of test flights. Europe I would not buy any of the first 50 Dreamliners. Europe
ON OUTSOURCING

Boeing outsourced so much because they initially strove to buy the very best components around the globe at a competitive price; however, this concept turned out to be a failure. Europe All planes have some outsourced components. As a new plane design, this one has more outsourcing than most. Boeing is just screwing it all together. Most of the suppliers are sole-source; you cant get the components from anywhere else. This means that theyre all sharing the risk. United States

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8 1 1

1.

Are you familiar with either the Boeing 787 or the Rolls-Royce Trent 1000 engine? Both: Boeing 787: Rolls-Royce engine:

2a.

Are you familiar with the uncontained failure of this engine that happened during a test in the United Kingdom in August? Yes: Yes, partly: 9 1

2b.

How are you familiar with this problem? (Some sources gave more than one answer.) Many contacts in the industry: Familiar with the engine problem: Newspapers: Potential airline customer: 8 3 3 1

3.

Is the publicized cause of this incident (a fault with the oil system, which led to a fire developing inside the engine) accurate? Yes: No: 9 1

4.

Why did the incident happen? (Some sources gave more than one answer while others did not respond.) Engine design: Botched testing: New development: Other: 8 5 5 1

5a.

Was this a unique event, or does it point to a systemic design failure that will require a total rethinking of the planes power plant? Both: Unique event: Dont know: 3 3 4

5b.

Why was this a unique event or systemic failure? (Some sources gave more than one answer while others did not respond.)
UNIQUE EVENT AND SYSTEMIC FAILURE

Engine design: Botched testing: Maintenance issue:

UNIQUE EVENT

2 1 1 3

New development: 6a.

Should Boeing continue utilizing the Rolls-Royce Trent 1000 in the 787? Yes: 10

6b.

Do you expect Boeing to continue using the Rolls-Royce Trent 1000 in the 787? Yes: 10

7a.

Do you agree with Boeings public statements that Rolls-Royce engine delivery issues are to blame for the latest delay in the 787 delivery? Yes, partly: No: 9 1

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5 4 4 3 2 6

7b.

What do you think are the other issues affecting the delivery of the 787? (Some sources gave more than one answer.) Outsourcing issues: Botched testing: Horizontal stabilizers from Alenia: Overly aggressive timeline: Flight control software: Other:

8.

Will this incident delay the delivery of the 787 past February? Yes: Maybe: Dont know: 7 2 1

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PAGE 7 | IMPORTANT DISCLOSURES

SEPTEMBER 30, 2010

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IMPORTANT REQUIRED DISCLOSURES

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