Spirit AeroSystems Holdings, Inc. (NYSE:SPR) Q3 2023 Earnings Call Transcript

Spirit AeroSystems Holdings, Inc. (NYSE:SPR) Q3 2023 Earnings Call Transcript November 1, 2023

Spirit AeroSystems Holdings, Inc. beats earnings expectations. Reported EPS is $-1.42, expectations were $-1.56.

Operator: Good morning, everyone, and welcome to the Spirit AeroSystems Holdings, Inc. Third Quarter 2023 Earnings Conference Call. My name is Seb, and I’ll be the coordinator today. [Operator Instructions] I would now like to turn the presentation over to Ryan Avey, Senior Director of Investor Relations and FP&A. Please proceed.

Ryan Avey: Thank you, Seb, and good morning, everyone. I’m Ryan Avey. 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’d like to turn the call over to our Chief Executive Officer, Pat Shanahan.

A landscape view of a passenger and cargo airplane taking off from the airport runway.

Patrick Shanahan: Great. Thank you, Ryan, and good morning, everyone. Welcome to Spirit’s Third Quarter Earnings Call. It is a privilege to be here with you today representing Spirit AeroSystems and our global team. I want to thank the Board for entrusting me with this responsibility while we search for a permanent CEO. On behalf of the entire Board, we thank Tom Gentile for seven years of dedication and service with Spirit. I’m very familiar with Spirit and its operations from my time at Boeing and as a Board member for the past two years. My trips to Wichita go back to the ’90s, where we tackled new programs and production rate increases together. Now I am the supplier, not the customer, but the dynamics are the same. Over the past several years, Spirit has expanded its portfolio of commercial and defense businesses.

However, the core of the business, designing and building large-scale aerostructures, has not changed. I’ve been in the role for about 30 days now. To borrow a military acronym, my approach since the first day has been TACOMO: Take charge and move out, meaning I’m with the Spirit team at all levels, deep into program and production rate plans and engaging with all our major customers. My initial impressions are that we have a strong team and tremendous capabilities, but we need better precision in our plans, better performance and the right schedule. We are manufacturing a product we’ve produced in large quantity at high rates before, as opposed to being in the throes of complex commercial development while concurrently ramping up production.

My focus is simultaneously stabilizing operations, delivering on our customer commitments and strengthening Spirit financially. I want 100% alignment with our commercial and defense customers. I’m driving performance every day. And most importantly, building cohesive teams that view working together as the most effective way to perform and win. The recent agreement with Boeing was an important step in the right direction. The strengthened partnership will support our shared goals of both companies to execute the increasing production rates. Also, I’m devoting increased attention to our other major OEM commercial partnership. Let me touch briefly on our strategy. I do not intend to wait for my replacement before moving forward. Regarding diversification, I will narrow the aperture.

I don’t have an appetite for next square adjacencies. We at Spirit will build on our core defense and aftermarket success. My principal goal is to be cash flow positive as soon as possible. Executing on programs, increasing deliveries is the most crucial lever to achieve that goal. However, we have other cash levers to pull to accelerate many of the activities previously developed, along with new ones we are uncovering every day. Shifting the discussion to market demand, it’s incredible what a difference a couple of years make. We are witnessing unprecedented demand. I’m encouraged by the unbelievable organic growth in our core segment with a $42 billion backlog. The demand comes with challenges that we must mitigate as part of a new world that is less stable.

I recognize we have disappointed our stakeholders. We want to restore confidence in the company. I’m passionate about this industry, our customers and Spirit. I’m in Kansas most days because this is where most of the action is. The people here and, quite frankly, at all our operations have been warm and welcoming. I’d like to provide you guidance for 2024, but I’m not prepared to at this time. My plan is to give guidance on our next earnings call, consistent with previous practices. I’ll now turn the call over to Mark to review with you our third quarter financial results.

Mark Suchinski: Thank you, Pat, and good morning, everyone. As many of you know, I have known Pat as a member of our Board for a while now, and I look forward to working closely with him as we navigate the path forward. I can tell you that we are aligned on our priorities and the trajectory of Spirit. Now turning to recent events, we are pleased to have reached a memorandum of agreement with Boeing in October, which we expect will result in improved cash flow over the next several years. I want to highlight the financial impacts of the agreement, which will be reflected in our financial results beginning in the fourth quarter. First, the MOA established an immediate higher price on the 787 program, with reductions to pricing on the 737 program beginning in 2026.

We expect to record a reversal of a forward loss and material right obligations of $350 million to $370 million as a result of the 787 price increase. With this, a majority of the existing 787 forward loss liability will be reversed, and we anticipate positive margins on the program beginning in the first half of 2025 as production rates increase. Next, the MOA provided for a broad release of existing claims and liabilities, which will include the reversal of $23 million of anticipated claims previously recorded related to the 737 vertical fan attach fitting issue. In addition, we will receive funding for certain tooling and capital through 2025 on the 737 and 787 programs. We will repay the majority of the capital funded related to the 787 program beginning in 2025.

In October, we received an advance on the total expected CapEx funding of $100 million. Between now and 2025, there will be some timing differences between the receipt of funds and the CapEx spending, which will be reflected on the statement of cash flows. And finally, the repayment dates were extended on the previously disclosed $100 million — $180 million advance of customer financing received in the second quarter of this year. We will now make repayments of $90 million in December of 2025 and equal repayments of $45 million in December of 2026 and 2027. The MOA strengthens the relationships with our largest customer and further aligns the parties for future success. Broadly speaking, the agreement provides increased cash over the next several years, which will help support production rate ramps across the different Boeing programs.

Now let me take you through the details of our third quarter financial results, which I remind you does not reflect any impacts of the recent Boeing MOA. So now let’s start on Slide 2. Revenue for the quarter was $1.4 billion, up 13% from the third quarter of 2022. Year-over-year improvement was primarily due to higher production on almost all of our commercial programs as well as increased Defense and Space and Aftermarket revenues. Overall deliveries for the quarter increased 5% year-over-year. The third quarter 2023 revenue was impacted by disruption from the IAM work stoppage in early July and the 737 aft pressure bulkhead issue and continued supply chain and labor challenges, which resulted in less near-term deliveries, specifically on the 737 program.

We now expect full year deliveries on the 737 program of approximately 345 units to 360 units. Now turning our attention to EPS, we reported earnings per share of negative $1.94 compared to negative $1.22 in the third quarter of 2022. Excluding certain items, adjusted EPS was negative $1.42 compared to negative $0.15 in the prior year. Operating margin was negative 9% compared to breakeven in the same period of 2022, driven by higher changes in estimates and excess capacity costs recognized during the current period. Third quarter forward losses totaled $101 million and unfavorable cumulative catch-up adjustments were $64 million. This compared to $49 million of forward losses and $5 million of unfavorable cumulative catch-up adjustments in the third quarter of 2022.

The current quarter forward losses relate primarily to the 787 and A350 programs and were driven by higher estimates of supply chain labor and other related costs. The unfavorable cumulative catch-up adjustments relate primarily to the 737 and A320 programs, reflecting higher factory costs and rework costs related to the quality issue on the 737 aft pressure bulkhead. Additionally, excess capacity cost during the third quarter of 2023 were $56 million up from $31 million in the same period of 2022. Other income in the third quarter of this year was $7 million, compared to other expense of $42 million in the prior year. The variance was primarily due to noncash pretax charges of $73 million recorded in the third quarter of 2022, driven by the termination of our pension value Plan A as well as lower pension income during the current period.

Let’s now turn to free cash flow. Free cash flow usage for the quarter was $136 million. Cash usage increased compared to the same period of 2022, largely driven by the negative impacts of working capital and costs associated with factory disruption. Working capital was impacted by the disruption and work stoppage associated with the IAM strike at the beginning of the third quarter, rework and disruption costs related to the 737 aft pressure bulkhead issue as well as ramping to higher production rates on the 737 program. Third quarter 2023 cash from operations also included $50 million customer advance that was previously disclosed and the payment of the ratification bonus related to the IAM contract of $23 million. We have updated our full year free cash flow to reflect the lower 737 deliveries expected for the year and the impacts of the Boeing MOA, and now expect our full year free cash flow to be in the range of negative $275 million to negative $325 million.

With that, let’s now turn to cash and debt balances on Slide 3. We ended the quarter with $374 million of cash and $3.9 million of debt. Addressing the $1.2 billion of 2025 debt maturities is a near-term priority, and we continue to evaluate all refinancing options to address debt as well as our overall liquidity. Next, let’s discuss our segment performance, starting with the Commercial segment on Slide 4. In the third quarter of 2023, commercial revenue increased 10% over the same period of 2022 due to higher production volumes on almost all of our programs. Quarterly operating margin decreased to negative 7% compared to positive 4% in the prior year, driven by higher unfavorable changes in estimates and excess capacity costs recorded in the current period.

The changes in estimates during the third quarter, which I previously discussed, included forward losses of $87 million and unfavorable cumulative catch-up adjustments of $59 million. In comparison, during the third quarter of 2022, the segment recorded charges of $47 million of forward losses and $7 million of unfavorable cumulative catch-up adjustments. Next, let’s turn to the Defense and Space segment on Slide 5. Defense and Space revenue grew to $206 million or 27% higher than the third quarter of last year due to higher development program activity and increased KC-46 tanker production. Operating margin for the quarter decreased to 5% compared to 11% in 2022, primarily due to higher changes in estimates recorded in the current period. The segment recorded forward loss of $15 million and unfavorable cumulative cash adjustments of $5 million compared to forward losses of $2 million and favorable catch-up adjustments of $2 million in the third quarter of 2022.

The forward losses were primarily driven by higher production cost estimates on the Sikorsky CH-53K program and unfavorable cumulative catch-up adjustments that were primarily driven by the P-8 program. For our Aftermarket segment results, let’s turn to Slide 6. Aftermarket revenues were $97 million, up 21% compared to the third quarter of 2022, primarily due to higher spare parts sales. Aftermarket continues to grow along with the global air traffic recovery and is on track to meet the plan for the year. Operating margin for the quarter was 19% compared to 24% during the same period of 2022, driven by sales and model mix. With that, we’ll be happy to take your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question today comes from Seth Seifman from JPMorgan. Please go ahead.

Seth Seifman: Thanks very much. Good morning, everyone, and welcome, Pat. A bunch of questions here. A bunch of questions, but maybe I’ll just jump up. I wanted to ask you specifically, Pat, about two things that you said in your opening remarks. One is you talked about other cash levers to pull to accelerate. I wonder if you could expand upon that. And you also talked about having the right schedule. And I wonder when we think about 737 production from here, what does the right schedule mean? And what’s really — what are the two or three things that you think are most important to getting to adequate 737 profitability and not having more of these negative cume adjustments?

Patrick Shanahan: Sure, Seth. Happy Wednesday. Let’s maybe take the first one. The biggest, as I mentioned, the biggest lever to get to positive free cash flow is program performance. But that’s not a pass for the rest of the team to go after indirect costs. And those range from organization structure to enforcement of contracts with our suppliers to a number of the other traditional things you might address in terms of looking at inefficiencies or belt tightening. In addition to that, they are just things we have to stop doing. So in parallel to the other improvement activity, we’ve really accelerated our focus on every dollar matters, and let’s bring it to the bottom line more quickly. Your other question, I think, is really the most important issue that we’re dealing with right now, and that is the right schedule.

And what I’ve learned over my almost 40 years in this business, if you get the right schedule, everything else works. The schedule is a barometer for performance. And if you’re on schedule, you’re going to realize the appropriate costs. And if you get the right costs, you’ll get the right financial results. When I look at the schedule and hopefully, with the guidance we provided in terms of end of quarter deliveries, we did the math. And the math is, let’s adjust for holidays and nonworking days, our effective rate, when you look at deliveries is we’re at about 37 to 42 a month in the fourth quarter, delivering to Boeing. We have a path to the 50s in ’25. And the reason I say we have a path to the 50s is we’ve been there before. So it’s not something new.

It’s a question of how do we stabilize in our internal operations so that without the effort we’re using today, we can cost effectively with high-quality produce the fuselages that Boeing so desperately needs. The path is through rate increases. The two biggest levers for us are the supply chain and our own internal productivity. When you just look at producing 737 fuselages at 42 a month, it’s roughly 25,000 parts that go into one. And so at 42, that’s one million parts we need per month. And when you look at the amount of fasteners that we put in, it’s something on the order of 10 million a month. And so for us to produce, it’s really about being synchronized and stable. And there’s just a lot of detail that goes into achieving that. I believe that we’ll be able to stabilize here and meet Boeing’s demands in 2024.

I’d like to walk you through the detailed schedule that we’re working on. I would just tell you this, is that we’re not doing things parametrically. We’re down to looking at things by the day, by the train pull, by the supplier. I’ve been here only a short period of time, but the readiness that we didn’t have in the past is not the readiness you will see in 2024.

Operator: Our next question comes from Sheila Kahyaoglu from Jefferies. Please go ahead.

Sheila Kahyaoglu: Good morning, guys. And happy Wednesday to you, too, Pat. So I was wondering if you guys could talk about the free cash flow revision, $275 million to $325 million of usage. How are you thinking about the change there from the prior guide? How much of it is tied to the 737? And just as we think about the step-up in Q4, what really changes in first 30 days or so, on the job, what have you seen that could be an immediate improvement?

Mark Suchinski: Well, Sheila, let me just take the walk on the headwinds and the tailwinds. And then I think Pat can provide some additional color. The biggest impact to free cash flow from a headwind standpoint is fewer 737 deliveries. And I think the challenge that we have here is when we were staffed to 42 airplanes per month, we’ve been bringing in parts to help support 42 airplanes per month. And when we drop our deliveries from the previous forecast of 370 to 390 to 345 to 360, a lot of that cost is embedded into our system. And so by not delivering the aircraft, we’re not collecting the cash on the delivery. So I think the impact is a little bit bigger than you’ve put in your note as it relates to missing the deliveries.

The additional forward losses and the negative cume catch-up adjustments that we took is going to add some additional pressure to cash in the fourth quarter. And then we’re seeing lower A220 deliveries in the fourth quarter, and that’s primarily driven by a customer change in their schedule. On the flip side, positiveness from the Boeing MOA, the 787 price increase and the CapEx funding. So I think if you factor all those things in, the biggest impact, I would say, is the lower 737 deliveries and us being staffed and having the working capital in place, and we’re just not going to release that inventory and collect the cash.

Operator: Our next question comes from Myles Walton at Wolfe Research. Please go ahead.

Myles Walton: Thanks. Good morning. One quick clarification and then one question for you, Pat. So on the clarification, are you currently shipping to Boeing, conforming fuselages at this point? I realized that you were able to recognize revenue and earnings on sort of nonconforming and then fix after the fact. But if you can update us if you’re now conforming. And then, Pat, you made comments about diversification in your opening remarks. And just curious, I know you’ve been on the Board for a few years, and you’ve only been on the job for a very short period of time, but is diversification necessary to make Spirit a great company? It had 80% concentration of rev to Boeing just a few years ago. And obviously, the stock did quite nicely, and the revenue and earnings were actually pretty good. So is diversification required?