Spirit AeroSystems Holdings, Inc. (NYSE:SPR) Q1 2024 Earnings Call Transcript

Spirit AeroSystems Holdings, Inc. (NYSE:SPR) Q1 2024 Earnings Call Transcript May 7, 2024

Spirit AeroSystems Holdings, Inc. misses on earnings expectations. Reported EPS is $ EPS, expectations were $-0.44. SPR isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, ladies and gentlemen, and welcome to the Spirit AeroSystems Holdings, Inc. First Quarter 2024 Earnings Conference Call. My name is Candice, and I will be your coordinator for today’s call. [Operator Instructions]. I would now like to turn this presentation over to Ryan Avey, Senior Director, Investor Relations and FP&A. Please proceed.

Ryan Avey: Thank you, and good morning, everyone. I’m Ryan Avey, and with me today are Spirit’s President and Chief Executive Officer, Pat Shanahan; and Senior Vice President and Chief Financial Officer, Mark Suchinski. Before we begin, I need to remind you that any projections or goals we may include in our discussion today are likely to involve risks, including those detailed in our earnings release, in our SEC filings and in the forward-looking statement at the end of this web presentation. In addition, we refer you to our earnings release and presentation for disclosures and reconciliation of non-GAAP measures we use when discussing our results. With that, I would like to turn the call over to Pat.

Patrick Shanahan: Thank you, Ryan, and good morning, everyone. Let me say at the outset that I am so proud of the Spirit team and particularly proud of what we’ve accomplished through teamwork. I love this industry, our customers and the people that work in it. And we set out every day to make the industrial system better while ensuring safety, quality and compliance in the supply of our products and services. For Spirit, the primary objectives of stabilizing operations, delivering on our customer commitments and strengthening our company financially have not changed. We are laser-focused and continue to make real progress towards these objectives. Spirit AeroSystems is a critical component of a global network of engineers, manufacturers, customers and governments that comprise the aerospace industry.

In that context, I’m going to frame our ongoing efforts. Demand for commercial air travel remains robust and firm. Our collective responsibility at Spirit is to match capacity and capability short and long term. It is a responsibility that defines the company and is at the core of our commitment to our customers. So as the industry prepares to ramp up production, we are diligently working across the industrial system to ensure we possess and demonstrate the capability to deliver on our commitments. Before moving to other topics, I would like to address talks with the Boeing company about a possible acquisition. At the beginning of March, we responded to media speculation by confirming that we are in discussions with Boeing. Those discussions continue, and as all of you understand, I’m not at liberty to comment further.

When and if we have something to disclose, we’ll make an announcement. At our last earnings call, I spoke about Spirit’s rapid response in support of the FAA NTSB Airlines and Boeing resulting from the Alaska air accident. Those actions concentrated on mitigating human factors by improving mechanic proficiency, compliance, mistake proofing and observation. Those systemic changes continue to take root as our foundational relationship with safety and quality matures. Building on that foundation of improvement, we’ve expanded our actions to strengthen leadership, product conformity and governance. In terms of leadership, Gregg Brown has joined our team as SVP for Global quality. Gregg is an airline operator, an airline safety and quality expert and authority in the management of the FAA’s safety management system.

He most recently was the Vice President of Technical Operations at JetBlue. Gregg possesses expertise for Airbus and Boeing products having served in the industry and at Southwest Airlines for almost 4 decades. Steps to strengthen product conformity have been significant. The decision was made to fundamentally change the inspection process. This change aligns Spirit and Boeing efforts into a joint inspection. Partnering with Boeing, this transformative undertaking was industrialized in 34 days. Today, working shoulder to shoulder with a standardized 26 zone product verification process, the team’s verify conformity on the 737. Each week, the process improves in tandem with quality results being fed back to the teams working in station. Ultimately, our goal is not to streamline this operation but to move it further upstream to where the work is performed.

In the interim, utilizing end-to-end digital feedback and analytics, we are accelerating the quality improvements initiated in the first quarter. With critical new building blocks, process changes and insight, we have further reexamined governance. Breakthrough performance and safety and quality will be realized and sustained if teams at the point of production own their operations. We are moving from the office to the factory floor. We’re enabling integrated product teams composed of quality assurance, manufacturing engineering, factory operations, supplier management and the customer. This form of governance, which is not new to our industry, provides the requisite authorities, resources, inspiration and motivation that unlocks discretionary effort.

This change in governance is early stage, but has the greatest potential. Now I will provide context on cash usage for the quarter. As Boeing mentioned on their call, they deliberately slowed 737 production below 38 per month to incorporate improvements to quality and safety management systems, including reducing traveled work and addressing supplier nonconformances. The inspection process changed by Boeing in effect paused our ability to receive payment for completed fuselages. The implementation of the product verification required that we inspect all the fuselage stored in ship in place utilizing the new conformity process. This represents a total of 54 ship-in place units that needed to flow through the newly established process beginning March 1.

In the quarter, we produced 89 units and delivered 44 units prior to implementing the new process. The result was an increase of 45 fuselages to our work in process. To offset the lack of payment but recognizing the completion of fuselages, Boeing Advanced Spirit $425 million to be repaid in the third quarter as the production system returns to equilibrium. We appreciate greatly Boeing’s support operationally and financially as we strengthen the industrial system. Boeing is also modifying 787 deliveries due to supply chain challenges. Mark will provide additional detail. However, with the 737 production rate currently at 31 airplanes per month and 787 deliveries approximately 25% below original plans, we will make near-term adjustments to our supply chain to ensure optimal levels of inventory and rate capability.

We are closely coordinating with our supplier partners to mitigate the short-term disruption. Our intent is to quickly resynchronize the industrial system while still balancing the capacity and capability to snap back to future production rate increases. The Spirit team is focused on driving our safety and quality efforts, synchronizing supplier partner operations and aligning to meet our commitments to defense customers Airbus and Boeing. Turning to Airbus, as we’ve discussed on earnings calls over the past year, we’ve been attempting to reach a commercial agreement in the best interest of both companies. These conversations have yet to result in an agreement. As a result of this impact and the continued pressure on meeting the delivery targets demanded by the rapid rate in the Airbus A350 and 220 programs, we booked significant losses this quarter, including net incremental losses for anticipated performance obligations extending beyond 2026.

The strain on the supply chain being experienced by Spirit and other suppliers is both commercial and an operational risk. We have risen to the challenge thus far, and we’ll continue to work with Airbus to ensure that quality and safety remain the foremost considerations. And to close, while it’s not been the focus of my opening remarks today, I want to highlight the strong performance of the Defense and Aftermarket teams. They continue to execute day in and day out and are performing to their commitments operationally and financially. With that, let me turn the call over to Mark, who will take you through the financials before we open up the call to Q&A. Mark?

Mark Suchinski: Thank you, Pat. And good morning, everyone. As Pat covered in his opening remarks, there have been a number of events that have occurred since our last earnings call. I want to discuss the financial impacts of these items before getting into the first quarter results. First, the implementation of Boeing’s product verification process on the 737 program, including moving inspections and rework teams from [indiscernible] Wichita while no longer allowing travel work. This has been a collaborative effort to enhance quality and eliminate rework, but consequently has created delayed delivery acceptance in our factories, which has led to the buildup of undelivered units, higher levels of inventory and contract assets and lower cash flow.

We are working with Boeing to mitigate the slowdown resulting from the process changes. And despite the slow start, we are seeing signs of improvement. And in the long term, expect the benefit to be more synchronized with our customers’ inspection process. Over the next few quarters, we expect to have our production systems aligned and built up units delivered. Additionally, we have incurred factory and supply chain costs that were incurred to align with the higher 737 production rate, which has now been delayed. Our current rate is approximately 31 aircraft per month, and we now expect to remain at the lower than planned rate throughout the rest of the year. Similarly, on the 787 program, we are now anticipating delivering approximately 55 units during 2024, down from our original plan of approximately 80.

All of these items will have a negative impact on cash flow throughout the year, but I want you to know that we are strongly focused on liquidity and actions to improve our current position. Now let me take you through the details of our first quarter financial results. So let’s move to Slide #2. Revenue for the quarter was $1.7 billion, up 19% from the first quarter of 2023. The year-over-year improvement was primarily due to higher production on our Commercial programs and increased Defense & Space revenues. Overall deliveries in the quarter decreased 11% year-over-year as a result of fewer deliveries recorded on the 737 program due to the reasons I described in my opening remarks. The in-process and completed 737 fuselages that have not been through the new source inspection process are recorded as contract assets and not counted towards our ship set deliveries until accepted.

The overtime accounting revenue recognition on these units has been reflected in our quarterly financial results. Now let’s turn our attention to EPS. We reported earnings per share of a negative $5.31 compared to negative $2.68 in the first quarter of 2023. Excluding certain items, adjusted EPS was negative $3.93 compared to negative $1.69 in the prior year. Operating margin was lower compared to the same period of 2023, largely driven by higher unfavorable changes in estimates during the first quarter of 2024. First quarter net forward losses were $495 million and unfavorable cumulative catch-up adjustments were $39 million. This is compared to $110 million of forward losses and $12 million of unfavorable cumulative catch-up adjustments in the first quarter of 2023.

The current quarter 4 losses were primarily driven by A350 and A220 programs of $281 million and $167 million, respectively. I know these are large losses but are really due to the inability to reach a conclusion to commercial negotiations with Airbus. And as a result, we were required to adjust our assumptions and record forward losses on the A220 and A350 programs, which drove $373 million of total losses. This includes forward losses through 2025, our current accounting contract as well as losses for anticipated performance obligations beyond 2026. The remainder of the forward losses were a result of production cost growth and additional firm orders. Additionally, the 787 program drove $34 million of forward losses due to supply chain and labor cost growth to support future higher production rates.

The unfavorable cumulative catch-up adjustments primarily related to increased 737 costs associated with the product verification process changes, which caused delayed delivery acceptances and a significant buildup of undelivered units in Wichita. Now turning to free cash flow. Free cash flow usage for the quarter was $444 million compared to free cash flow usage of $69 million in the first quarter of 2023, primarily caused by disruption to the 737 production and delivery delay experienced in the period. Having a large number of unbilled 737 units built during the first quarter had a significant negative impact on our first quarter free cash flow. Once these units can be fully inspected under the new product verification process, they will be considered delivered, and we can collect the cash earned on those units.

The prior year free cash flow reflects $180 million surplus cash payment received related to the termination of the pension value Plan A. Now with that, let’s turn to our cash and debt balances on Slide 3. We ended the quarter with $352 million of cash, which reflects the unfavorable impacts of the disruption experienced on the 737 production and delivery process. We ended the quarter with $4.1 billion of debt. In April, we entered into an MOA with Boeing to provide cash advances totaling $425 million. These funds were used to address Spirit’s high levels of inventory and contract assets, lower operational cash flows, decreased deliveries and higher factory costs attributed to the change in the product verification process and the FAA’s imposition of limitations on the Boeing increased production rates.

This advance will be reflected in the second quarter financial results and will be treated as financing activity on the statement of cash flows. As I mentioned in my remarks, we are strongly focused on liquidity and our working plans to improve our current position. Next, let’s discuss our quarterly segment performance, along with the Commercial segment on Slide 4. Even with the 737 disruption impacts, Commercial revenue increased compared to the same period of 2023, primarily due to higher production across most of our programs. Quarterly operating margin decreased compared to the first quarter of 2023, primarily driven by higher changes in estimates recorded in the current period. These changes in estimates included net forward losses of $494 million, which were largely driven by the change in assumptions on our conversations with Airbus and unfavorable cumulative catch-up adjustments of $39 million.

In comparison, during the first quarter of 2023, the segment recorded charges of $110 million of forward losses and $11 million of unfavorable cumulative catch-up adjustments. Next, let’s turn to Defense & Space segment on Slide 5. We are especially pleased with the performance by the Defense & Space teams this quarter. Revenue grew to $251 million due to higher activity on development and classified programs as well as the Sikorsky CH-53K and FLRAA programs. Operating margin of 13% in the first quarter increased compared to the same period of 2023, primarily due to higher classified program activities and strong execution by the team. For our Aftermarket segment results, let’s now turn to Slide 6. Aftermarket had another solid quarter with revenue of $96 million, up slightly over the prior year, primarily due to higher spare parts sales.

Operating margin in the first quarter of 2024 decreased compared to the first quarter of ’23, primarily due to lower MRO activity during the current period. With that, we will be happy to take your questions.

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Q&A Session

Operator: [Operator Instructions]. So our first question comes from the line of Seth Seifman of JPMorgan.

Seth Seifman: I was wondering, Pat and Mark, if you could talk about when we think about the potential deliveries from Spirit this year, and we think about the current production rate of 31, but the deliveries we saw in the first quarter, should we think about the rest of the year as being kind of that 31 per month plus, I guess, the difference between the 89 that were produced and the 44 that were delivered in the first quarter? Or will it take more time to kind of marry up the actual deliveries that can happen with that sort of underlying production rate of 31 a month? I guess, how should we think about that trajectory of deliveries going forward and when those deliveries meet up with the production rate and how the excess fuselages come out over the rest of the year or longer as well.

Patrick Shanahan: Yes, Seth, maybe just think about it this way. We’ll be steady state at 31 aircraft per month for the balance of the year. And you might think of that ship in place as a buffer that will allow Boeing to increase to 38 per month when the time is appropriate based on their work with the FAA. So I kind of think of that buffer as surge capacity. Based on the volume that’s there, it positions us then to respond should the rate go higher.

Mark Suchinski: Yes, Seth, just a little bit more color here for you. Let’s just focus on Spirit deliveries, okay, where we’ll get paid cash. I’d expect the second quarter cash deliveries to be consistent with the first quarter as we work through the product process verification and then we’ll see our deliveries increase higher than that in the third and fourth quarter so that for the full year, the deliveries will be roughly 31 a month x 12. So we have some more ship in place Boeing owned inventory that needs to go through the process verification in the second quarter. And then our finished goods will start to follow after that. So delivered units revenue — or cash delivered units, again, will be consistent with the first quarter, and then we’ll see those go higher in the third and fourth quarter.

Operator: Your next question comes from the line of Sheila Kahyaoglu.

Sheila Kahyaoglu: I wanted to ask about Airbus and the assumptions there. Just what were the assumptions within the A220 and the 350 per pricing given part of the forward loss in the quarter was tied to the failure to reach a new pricing agreement there? And was there some sort of relief assumed in those numbers?

Mark Suchinski: Yes, Sheila, thanks for the question. Yes, there were embedded in our previous assumptions, an assumption on a higher price based on discussions that had ensued at the time. As we said, we haven’t been able to come to a conclusion on that. So the forward loss is really represented, I think, in 3 components. Number one is it’s a reversal of that pricing benefit that we previously booked. It’s additional orders that Airbus booked beyond 2026 on both A350 and A220. And so while we’re a stand-alone company, we need to continue to record losses on those future performance obligations. And then there were just some normal cost growth associated with the production. But in my remarks, I said specifically the reversal of those benefits and the additional losses on the future performance obligations were roughly $373 million of the total Airbus losses.

Sheila Kahyaoglu: Maybe just to clarify, can you level set us on what sort of cash usage we should assume for the Airbus business in ’24 and ’25?

Mark Suchinski: What I would say is this, Sheila, if you look at our balance sheet and you look at current forward loss reserves or liabilities, I would say that Airbus is about 80% to 85% of those balances. So I think you can do some math from there.

Operator: The next question comes from the line of Jason Gursky of Citigroup.

Jason Gursky: Pat, I was wondering if you could just spend a few minutes kind of contextualizing for all of us. The scale of the changes that the ecosystem is going through here. And this idea of reducing traveled work to 0 essentially, I’m guessing is, what’s being asked of you. How do you think of a philosophical changes this in aerospace manufacturing? And how difficult is it going to be to achieve what’s being asked of you and in turn, what you’re asking, I suspect your suppliers to do? I think just big picture, giving us a really good understanding of the task at hand here and how maybe normal this is going to be? Or how unusual this is going to be, I think, would be helpful for all of us here on the call?

Patrick Shanahan: Sure, Jason. Let me kind of break it into some different pieces. So when we think about the process that’s been stood up here in Wichita, think about it in terms of there are many points along the production system, and I’m going to characterize that as production system for this discussion starts in Wichita and ends when we load a fuselage into the rent in facilities, there are many points along that process where inspections take place. And this effort with Boeing has been to better align all of that activity so that we can take the feedback from those inspections and drive cause corrective action at a very top level, that’s what we’re talking about. The details are more complicated than that in the sense that in our production system in Wichita, we conduct 9,000 inspections.

When you think about the fuselage that we delivered to Boeing, it’s 100 feet long and about 12 feet in diameter. It’s the largest single integrated commercial aerostructure in the world, and we have very exacting tolerances in which we have to build that to from an engineering standpoint. So when we talk about skin quality, skin quality must be within 10,000 [indiscernible] roughly the thickness of 2 sheets of paper. So when we think about that fuselages about the size of a high school basketball court. And when Boeing says, we expect perfection, they’re talking about nothing in excess of 2 sheets of paper thickness. We also install on the skin, 100,000 — it’s about 100,000 fasteners. So there are no fasteners that can have a tolerance greater than what you could detect with your fingernail.

So what we’ve done here is to consolidate all of these inspections where there’s a final inspection in Wichita before it goes to Boeing. And when Dave Calhoun talks about clean fuselages, the definition there is what we ship to them, they can load into their first position and immediately put floors down at blankets And the goal is that they can immediately go to work because what we provide to them is the pacing item for all of those installations, we cannot travel any type of work that would disrupt their ability to start on day 1. I think we’ve made substantial improvement in realigning all the inspections, interpreting the engineering specifications in an exacting manner so that the eyes of Boeing and the eyes of Spirit are the same. And we’ve been migrating away from humans doing this to digitally inspecting the condition of assembly.