Q3 2019 Earnings Call
Good morning, ladies and gentlemen, and welcome to Spirit Aerosystems Holdings incorporated third quarter 2019 earnings Conference call My.
My name is Chad and I will be your coordinator today.
All participants will be they listen only mode should you need assistance. Please signal a conference specialist by pressing the star key followed by zero.
After today's presentation, there will be an opportunity to ask questions.
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Please note this event is being recorded.
I would now like to turn the conference over to Ryan Avi Director of Investor Relations. Please go ahead.
Thank you Chad and good morning, everyone. Welcome spirits third quarter 2019 earnings call I'm, writing Baby Director Investor Relations and with me today, our spirits, President and Chief Executive Officer, Tom continually and Spirit Senior Vice President and Chief Financial Officer Jose Garcia.
After opening comments my time and Jose regarding our performance and outlook, we will take your questions.
In order to allow everyone to participate in a question and answer segment. We asked whats your limit yourself to one question. Please 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, which are detailed in our earnings release or SEC filings in the forward looking statement at the end of this web presentation.
In addition, we refer you to earnings release in presentation for disclosures and reconciliations of non-GAAP measures, we used when discussing our results.
And as a reminder, you can follow today's broadcast and slide presentation on our website, that's you're not spirit Aero dotcom with that I'd like turn call over Chief Executive Officer, Tom can truly thank you Ryan and good morning, everyone. Welcome to spirits 2019 third quarter earnings call. This is an exciting corridor for spirit and we have a lot to discuss today first we're done.
Why didn't you announced the planned acquisition of select from Bharti, a aerostructures and aftermarket sites in Belfast Casablanca in Dallas This acquisition aligns very well with our strategic priorities of capturing more Airbus business, expanding our low cost country footprint in scaling our aftermarket business with good long term shareholder returns.
Now, let's take a look at third quarter results and highlights before describing the been Bharti aerostructures acquisition in more detail.
Spirit posted solid operational results in third quarter, driven by improved execution and the cost mitigation actions, we implemented last quarter to lessen the financial impact of remaining at a rate of 52 aircraft per month on the 737.
The entire spirit organization embrace the challenge to align our cost structure with the lower volumes that the Max grounding created for this year well we made good progress on cost mitigation actions, we must maintain our focus on operational efficiency quality improvement to achieve our margin targets.
Well, we continues to work with global regulators to return the Max to service.
We remain very confident in the long term outlook for the Max and are proud to be a partner on the program. We're continuing to produce at a rate of 52 aircraft per month as we agree with Boeing and currently have about 65 shipsets in storage at our facilities.
We communicate with Boeing regularly and will coordinate our production rates with them based on the timing or the Max returning to service.
Now, let's take a closer look at third quarter results revenue was $1.9 billion up 6% over Q3 of 2018.
Adjusted EPS decreased 19% to $1.38, which was impacted by the forward loss recognized on the 787 program as a result, the Boeing's recently announced production rate decrease.
The absence of a recovery of legal fees last year and higher tax rate in this years quarter.
The 77 forward loss of $33 million resulted in an EPS impact of 24 cents.
Excluding the impact of the 77 charge adjusted EPS for the quarter would've been a dollarssixty two.
Adjusted free cash flow increased 68% to $219 million included $123 million of a cash advance from Boeing to help maintain our supply chain help and offset working capital headwinds throughout the 737, Max grounding period.
Normalized Q3 segment margins improved to 16.4% from 15% in Q2.
Our focus remains on aligning our resources to the lower production level of 52 aircraft per month on a 77 as we exit the year.
We are continuing to take full advantage of this pause in the rate increase to improved quality factory efficiency and supply chain how.
These actions combined with the benefits from a longer period of rates stability will help us attain our goal of 16.5% margins for next year.
Although we are most of the way through this year. The fact that the Max is still grounded means that we have uncertainty on our production rate.
Therefore, we are unable to provide guidance at this time until we have further clarity on the timing of the Max returned to service and the 737 production schedule.
Our current expectations are that we will continue to produce a rate 52 in order to burn off the excess stored inventory after Boeing eventually transitions to rate 57.
Given current production in storage levels, our expectation is that we will not produced at a rate higher than 52 through 20, 2021 and possibly into 2022.
This level of stable production will enable us to continue improving our quality and efficiency on the program.
We expect issue 2020 guidance as we normally do when we report fourth quarter earnings for 2019 next January .
Jose will provide a more detailed financial overview in a few minutes.
Now turning to slide two in the presentation will talk now about this exciting acquisition of the select from BARDA Aerostructures assets.
Well Bharti Aerostructures deal brings customer diversification.
Our low cost country footprint and expanded aftermarket content all of which are in line with our stated strategic growth priorities.
This acquisition increases our Airbus content on the eight to 20 and the Athree hundred 33, Twentyneo, both strong and growing platforms. The Belfast site design and manufacturers the wing for the 220, which has a state of the our composite resin transfer infusion Wayne.
They will also produced the Athree 20 thrust reverser for the Pratt Whitney geared turbofan on the Athree hundred Twentyneo.
The acquisition more than doubles, our aftermarket business and expands our capabilities in high margin maintenance repair and overhaul content.
Representing about 20% other revenue today the majority a aftermarket business supports recurring work for thrust reversers and other structures, serving a worldwide network of airline customers.
The facility Casablanca broadens, our low cost country footprint, providing spirit within established space and the growing aerospace hub of Morocco.
Very Jason to Europe . The deal also includes life of program contract on all of them Bharti, a business jets, including the global 7500, which recently entered into service.
Now moving to slide three looking at the Aerostructures capabilities of this new asset.
The sites to be acquired have 4000 employees with the history dating back more than 100 years and a proven track record of developing aerostructures and significant aftermarket capabilities.
They can provide end to end design certification production and aftermarket services.
They also have a world class engineering organization with a long history of innovation, particularly in composite material, including resin resin transfer infusion technology.
The Bharti Aerostructures business, we are acquiring has a strong and increasing backlog with long term contracts for an attractive diversified mix of mature and growth programs.
Future revenue growth is driven by the way to 20, the Athree hundred Twentyneo and the global Express 7500.
The eight to 20 aircraft has already achieved a backlog of more than 430 units and is well positioned as a growth platform.
This business that we are acquiring is the exclusive supplier of the eight to 20 link. This business also recently won the Athree hundred Twentyneo Pratt Whitney thrust reverser package, highlighting the value proposition they bring in terms of operational capability and cost competitiveness.
Our aftermarket business has grown at twice the rate of the market since 2006, providing solutions for into cells.
Those Cowles bank outdoors aprons thrust reversers and engine build units. They currently service a mixture of maturing growth platforms, well positioned to drive revenue for decades to come.
BARDA Aerostructures also has an exception exceptional reputation for innovation quality and on time delivery. They have a strong experienced management team with excellent customer relationships.
The deal includes three sites shown on slide for the.
The Belfast site has a 100 year history, providing innovative aerostructure solutions dating back to the origins of flight that they signed a contract to produce the first six right Flyers, becoming the world's first registered aerospace manufacturer.
Belfast today is a center of excellence for wings in the cells fuselages and composite material with a highly skilled engineering workforce.
The side has been a pioneer in composite material innovation dating back to the 900 seventys through today highlighted by the technologically advanced eight to 20 way.
They are well positioned for the next generation of aircraft development with their expertise in resin transfer infusion.
The Casablanca site provide spirit with an established facility and the growing aerospace hub of Morocco.
Aside as a best cost solution with a strong track record of successfully introducing work packages and quickly ramping up production achieving significant cost reductions.
Rocking government is committed to developing in supporting a world class aerospace industry.
The facility in Dallas offers MRO and modification capabilities specializing in the cell and flight control surfaces.
They provide extensive aftermarket support an Airbus Boeing Bharti aircraft to many key flagship airlines.
Now, let's turn to slide five for the financial details and deal economics.
We are acquiring select assets have been bharti aerostructures for cash consideration of $500 million. In addition, we'll assume $300 million in net pension liabilities and $290 million of government grant repayment obligations for total enterprise valuation of $1.090 billion at.
Closing will pay $500 million to Bharti and make a cash contribution of approximately $130 million toward the pension liability for a total cash consideration at closing of $630 million.
This reflects a pre synergy 2019, EBITDA multiple of 10 times.
In a post synergy multiple of 6.5 times.
We expect to capture synergies of approximately $60 million driven by supply chain engineering and administrative costs.
Investment returns will exceed 10% and the deal will be accretive in the first full year, excluding intangible amortization.
2019 revenues are expected to be approximately $1 billion.
The acquisition is expected to close in the first half 2020 upon completion of regulatory approvals and other customary closing conditions.
Key approvals include merger approvals required and six regions.
Customer consents and government grants, we have already received Airbus consent.
We expect to fund the acquisition with cash on hand.
Now turning to the status of the ASKO acquisition.
The cyber attack that we've described in the past that ESCO experienced in June caused delays and the data segregation process, which was a requirement to meet the conditions of the European Commission approval.
ASKO has now restarted the data segregation process and we have agreed to extend the long stop date to April 2020.
We discuss various structures to the deal with the seller and based on those discussions we mutually agreed on a reduced price of $420 million and other additional terms, which provide adequate compensation for any potential impact stemming from the cyber attack and for the expenses. We have occurred since the deal was announced in May of 2018.
Also we extended the long stop date to provide adequate time to complete the closing conditions. Following the cyber attack. The ASCO team has worked very hard to recover their systems and restore production.
The financial forecast for the business remains strong and we continue to be excited about the strategic fit and financial outlook a basket.
The acquisition expands our Airbus content as new defense content, specifically F 35 work and broadens our fabrication business.
And now a few other recent highlights spare was recently recognized with the award for composite excellence in manufacturing material and process innovation at the composite and advanced material Expo for the development of the advanced structures technology, and revolutionary architectures or Astra demonstrator panel.
So same one that we took to the Paris Air show.
The Astra demonstrator is a full scale composite few slides skin panel that combines advanced manufacturing technologies, and revolutionary architectures and carbon fiber to cut roughly 30% of future composite fuselage costs.
The National Institute for Aviation research or Nyjer at Wichita State University supported the development of this technology by completing hundreds of structural validation test.
As part of our collaboration with Nyjer. We also recently celebrated the Grand opening of our offices at the innovation campus at which saw state University.
We now have almost 80 scientists and engineers working on advanced technologies to improve manufacturing efficiency.
We view innovation and metallic and composite structures as a differentiator and core competency for spirit.
With that I'll ask Jose lead you through the detailed financial results Jose.
Thank you Tom.
Good morning, everyone on happy Halloween.
We same back in Spain believe via the total centers.
Let me summarize our third quarter the financials.
Please let's move to slide four.
Revenue for the quarter, there was 1.9 billion.
Up 6% from the same period of 28 team.
This growth was driven by higher volume so production on the 3.7.
787 on Athree 50 programs.
As well as higher revenue recognized on the 787.
Let's now turn to earnings per share.
On slide seven.
We reported adjusted bps or by the all are set up the eight cents per share compared with $1.70 in the fed up what a bit of 28 team.
Excluding the impact of disseminate seven forward loss.
We sold a boeing's recent announcement.
To be pleased for action to 12, they've got Vermont.
From the prior 14 per month.
Adjusted EPS would have been a $1.62 cents.
Adjusted EPS excludes.
As in prior quarters, the impact of expenses related to the Asquith acquisition.
And a small gain related to that we want a retirement program.
We announced in Twoq.
The adjusted BP as decrease year over year Westbury merrily due to the forward loss on the 787 program.
So I was hoping from volumes recent announcement to decrease rate.
A higher tax rate of 24% this quarter compared to 18% in the same quarter last year.
On the non repeat over litigation recovery last year.
All of these partially offset by improved performance on favorable model mix on the seven cities and program.
And could you just after market that Pete.
The forward loss on the 787 program.
Reflects the impact of fixed cost absorption.
Due to extending the current accounting block by four months.
The current accounting block runs through line units sort of five.
On will now close in the fourth quarter bit of 2022.
The benefits of the cost mitigation actions that we announced earlier in the year will continue into Q4.
On into next year.
Yes, we will be efficiency on the quality improvements on our largest program.
From honest from on a stable 737 production bleed.
These gains will be partially offset by prices step downs.
On the 77 on Athree 50 programs.
In Q4 on 2020.
As we have previously discussed these step downs are contractual.
On occur start then milestone units.
This price step Downs of course are already contemplated in our stated margin on cash targets.
But can create short term headwinds in the quarter in which they occur.
For the quarter.
Normalized segment margins were 16.4%.
Compared to 15 person in Q2 the easier.
Reflecting the higher work on cost reduction.
Im more stable operations.
While we remain above a 52.
While we continue to target 16.5% margins next year.
We are likely to see some pressure in Q4.
As the customer prices they've downstate defect.
Now turning to slide eight.
Free cash flow.
Adjusted free cash flow for the quarter better was 219 million.
Compared to 100 on therapy Museum in the third quarter of 28 team.
These reflects a 68% decrease year over year.
Adjusted free cash flow excludes the impact of the acquisitions.
The adjusted free cash flow includes a 123 million.
Cash advance from Boeing.
The purpose of these events west to fund increasing abilities from suppliers, while we were reducing our rate of 52.
During the period of impacts the Max viz disruption.
I believe we Boeing these cash advance will be applied against future deliveries.
Let's now turn to capital deployment on slide nine.
As you know, we paused our share repurchases.
Bending further clarity surrounding the regulatory approval.
The Max returned to service.
Given our solid operational performance, we ended the third quarter better we'd have very healthy cash balance a 1.5 billion.
Additionally, we paid 12 million in dividends in the third quarter.
Our commitment to.
Through at least to blame on balanced approach to capital deployment remains unchanged.
Now, let's look at our segment performance on slide 10.
For our fuselage segment results.
Please turn to slide 10.
Fuselage segment, but I've entering the quarter bid was 1 billion up slightly from the same period last year.
This was due to higher production volumes on the 77 and basically 50 programs.
As well as higher but I've been recognized on the 787 program.
Operating margin for the quarter was 10.5%.
Compared to 13.6 person in the same period last year.
Primarily due to the 787 forward loss.
Recognized as a result of Boeing's announced decreased to 12 rate.
And higher costs.
Related to a 77 program.
Largely resulting from the impact of the Max dialing.
On a normalized basis after reversing changes in estimates.
From prior periods.
Personalized segment margins improved sequentially to 15.8% instead of quarter compared to 13% last quarter.
Now turning to slide 11 for our propulsion segment results.
In the third quarter.
Propulsion, but I have in the west 521 million.
Up.
In person compared to the same period last year.
Primarily driven by favorable model mix on the 737 program.
On higher production volume bonded sequel seven program.
Operating margin for the quarter better was strong at 21.4 person.
Compared to 17.2%.
That said report that of 28 team.
Primarily due to favorable 77 model weeks.
On a normalized basis.
After reversing changing estimate impacts.
Propulsion segment margin was 21.9%.
Up 400 basis points compared to the same vehicles last year.
We have done a lot of work on driving improvements in proportion margins.
And those efforts are starting to leave of resource.
For our wing segment results, let's turn to slide 12.
We live in during the quarter bit of west that he kind of a 91 million.
Up 3% compared to the same period last year.
Driven by higher production volume on the table seven.
On 787 programs.
Operating margin for the quarter, but it was 17.8%.
Compared to 15.5% instead of one of two and the team.
Primarily due to the 787 forward loss.
Now, we'll recognize that's obvious holder boeing's announced production base.
12.
On a normalized basis after reversing changing estimate impacts.
Wing segment margin was 15.4 person.
Up from 15%.
In the same period of last year.
Okay.
As Tom mentioned, we the Max steel grounded.
It is as steel uncertainty around production rates.
And we will not be providing full year outlook for 2019 at this time.
We expect to provide full year 2020 guy them on our next earnings call in late January .
When we have more clarity on the Max return to service dates.
And borrowings associated production schedule.
In closing.
That said affordability soles reflect good, but otis, especially on the actions to reduce cost and improve working capital.
To partially offset our challenge on fixed cost absorption.
From lower production rates on the 77.
Having said that that is just feel more work to do.
In terms of improving quality and efficiency in our factories.
Our improved execution all these items will enable us to meet our margin commitments next year.
With that I will turn it back over to Tom.
For some closing comments, thanks, Jose and now I'll make some closing comments before we take questions. The acquisition of and Bharti a assets is a transformative deal for spirit aligning perfectly with our stated strategic goals of capturing more Airbus business, expanding our low cost country footprint and scaling our aftermarket business post synergies.
The acquisition price represents 6.5 times, 2019, EBITDA, which trades below or spirit currently trades and delivers investment returns in excess of 10%.
The criteria that we've always discussed.
In addition, this quarter, we restructured the terms of the Asquith acquisition to reflect the delay in closing the transaction and agreed with the sellers to a purchase price of $420 million.
We remain confident the strategic fit and financial outlook of Vasco and look forward to closing the deal early next year.
Operationally following the Max grounding, we've taken actions on cost control and working capital to mitigate the impact and it made good progress we made solid progress on our cost mitigation targets this quarter and even as we made investments in improved quality and efficiency. We are starting to see some of the benefits of a stable production rate in our factories.
Our focus for the remainder of the year will be to sustain progression towards optimizing our factories to deliver on our margin targets next year.
That said normalized margins this quarter were 16.4% and we remain remain on track to achieve 16.5% next year.
Even taking into account the customer price step downs that will start in Q4 2019 on the Athree hundred 50, and some other programs.
Cash flow this quarter was $219 million and year to date is $620 million demonstrating solid execution, even during the background with that we'll be happy to take your questions.
Thank you we will now begin the question answer session to ask a question you May Press Star then one on your telephone keypad, if you're using a speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then too.
Please ask that you limit yourself to one question. If you have additional questions. You may we ended the question Q.
This time, we'll pause momentarily to assemble our roster.
Our first question will come from Sheila Kahyaoglu with Jefferies. Please go ahead.
Hi, good morning, and thank you for the time.
Good morning.
Just a question for you I mean, clearly two deals in the past.
12 months I guess.
We are focusing on your goal of diversifying away from Boeing how do you think about somebody assets than in the past its been a struggle with is Jackson the Gulf stream business. How does this pack how does this asset different how do we think about the contract structure that work package.
Well first of all we don't have a goal of diversifying away from Boeing Boeing is our largest customer we have tremendous respect for them.
We want to continue to grow with Boeing at the same time, we do want to grow some of our other customers faster and so we stated that Airbus content military content fabrication, our key goals.
So so as we look at the Bharti eight assets for Aerostructures, you mentioned that they're in business Jets and they are and it's true that spirit has struggled in the past with some of its business jet programs, but the thing about the Bharti a global express in particular, where a lot of that structure is built in.
In in Belfast.
In terms of some of the control surfaces.
Around the end panache is that represents really a state of the art aircraft. It's got the longest range of any business aircraft recently completed.
A trip from Sydney, Australia, Detroit, Michigan, My hometown and that was a world record. So it's got great orders and it's really a great platform for the future. So we're we're very confident of that and we have life a program contracts with with somebody on that at very good pricing in.
In terms of the deal economics, and when we start to combine what we do in terms of engineering and design operations and particularly supply chain. We think we can bring even a lot more value to it. So so thats the the business jet side of it the other thing that the Bharti a assets have is a very significant work package.
On the Athree 28, excuse me the 220.
They make the entire wing with the resin infused technology for carbon fiber composites. This is a state of the art wing, we think it will give us a great head start in terms of future wing programs with Airbus and the eight to 20 is off to a good start itself. It's Scott over 500 orders in.
Total 500.
And 25 orders in total and it's got a backlog of about 435 aircraft. So it's in a very strong position and again Belfast makes the entire wing. So that is very attractive and then the other at the other program. They Havent Belfast is the Athree hundred 20 thrust reverser package, which Airbus awarded.
For the geared turbofan on the on the Athree hundred Twentyneo and then again represents a state of the our technology on obviously the biggest narrow body program that Airbus has in addition, these assets include Morocco, They have a big plant and Casablanca state of the art low cost.
But very good technology excellent workforce, a lot of engineering and this is going to be a great platform for us as we expand all of our programs in spirit and then finally I'll just highlight aftermarket.
This is really one of the hidden gems of of this acquisition, our they've got significant MRO capabilities in Belfast and also in Dallas and this is going to more than double our aftermarket.
Activities. This is scale work, they're very efficient.
They have tremendous customer relationships with airlines all over the world very competitive and we see this as an opportunity to really accelerate the growth of our actress aftermarket business. It's always been strong. This enables us to really take it to a completely different level. So on all those different fronts. We're extremely excited about this.
As a acquisition of the BARDA aerostructure assets. Thank you.
The next question will be from Seth Seifman with JP Morgan. Please go ahead.
Thanks, very much and good morning.
Tom I Wonder if you could talk a little bit more about the about the acquisition in terms of the synergies.
Bombarded based on a few rather of cost cutting and.
And it's Aerostructures business, and so kind of where are you feel like the synergies come from and also Airbus has been pretty explicit about looking for price cuts.
From suppliers has it has all of.
All those arrangements than been ironed out as part of that deal.
The answer to that is yes, we've we've talked with BARDA and with Airbus. Obviously, the two largest customers and we have agreed pricing and so thats all built into the deal economics, which gives us great comfort. So so that is definitely set when we think of the synergies we built in.
But 5% cost synergies and also some revenue synergies, particularly from MRO. So when we look at the MRO business and we look at what we do and what they do and we put those together there's going to be some significant revenue synergies, but on the cost side, it's really about playing to our strengths and.
I would say we are very strong in terms of creating a competitive world class supply base.
With a strategy that we have employed that has six pillars and starts off with clean sheet evaluations reverse engineering literally 100000 different parts. So no we know exactly what they cost as we take our supply chain strategy an overlay it with these lombardi assets, we see a lot of opportunity to go.
Yet, even more competitive pricing and more competitive supply and delivery.
We also see a lot of engineering synergies they've got great Engineering resources I mentioned, they develop the original right flyer back in the early days of aviation, but they've continued to really be at the forefront of innovation with things like the new Athree 20 thrust reverser, the all composite wing using resin fusion technology.
And so there's going to be a lot of opportunities on engineering.
That weighing also is really state of the our and his Airbus thinks about it swing of the future. We think that will give us a great platform to continue working with them and then and then typically in a deal like this in terms of the cost side of things, if we look at facilities and overhead and indirect cost and.
In functional expenses around the world will be able to get more economies of scale just because of the larger size that we'll be able to bring so all of those things will help us drive 5% cost synergies and also some significant revenue synergies I think I mentioned about $60 million total and post synergies.
When we look at the total enterprise value the the EBITDA multiples about 6.5%. So we're very very pleased with that it trades below where we trade and that was always one of our stated goals and looking at acquisitions.
Great. Thanks congratulations.
Thank you.
The next question will be from Ronald Epstein with Bank of America Merrill Lynch. Please go ahead.
Hey, good morning.
Hi, Good morning, maybe two things how do you think about the impact of 77 on on the business in terms of though.
The cut to run off from 14 to 12 and then.
How do we think about it for or to Jack.
From that down the road.
When we think about modeling all that out.
Right well as you know on the 787, when we announced our first collective resolution at the end of 2017, we announced a 373 million dollar forward loss out to line unit Fortino five and that's just reflected the pricing that we put in place now when we did our collective resolution.
Deal with falling at the end of last year.
We reset the pricing going forward after lining at 14 of five to be breakeven at that time.
And so because we are in a in a in a loss position right now when we went up in rate from 12 to 14 at the beginning of this year, we recognized a gain of about $40 million. So by going back down to 12, we reversed 33 million of it and it was just because we will be will be it will have been producing at 14 for.
18 months by the time they go back down to 12. So obviously there is a an impact when when rates go down if rates go down further that will create more pressure on our.
On our forward loss position and so we will we will recognize it accordingly, but.
Boeing has not made any indications that it will go down below 12 at this point. So, we'll obviously watch very carefully and work with them on that.
But what we are confident of is that after line unit 14, o'five the pricing increases to the point, where we think will be breakeven and a little bit better now they the lower rate will put some pressure on that about $100000. A unit. We're confident we can address that and still be positive in terms of our March.
Region after lining to 14 of five so.
The other thing about the to 77 is it's a great aircraft.
It's got great range, great fuel efficiency the airlines love. It it's opened up a lot of new city pairs and we think that we'll have a great opportunity a two to see that increase its sales and orders in the future and so I wouldn't be surprised as orders increase if Boeing relooked at its production rate.
Down the road.
The only thing Allied through what Tom Splaine is in terms of cash.
We do have a headwind, which is overhead absorption of the lower rate.
But because these are lost contact and Crossties about price, we have a tailwind on volume. So we will pickup some cash as we lose fewer units you go swing factor that repayment of scheduling some will be advances we have we going so net net on our cash basis. The impact is a long list them.
But on the earnings impact on the on the forward Rose.
Congrats on a gives us more time to get the the cost.
It will be low price.
We will add four months to the block. So these would be more timing in getting our our cost out.
As production or in that I. Please.
Gotcha, and then maybe just one follow on.
Related to the April MW Bohn, you guys got to $123 million advance.
If the 737 returned to service just takes a little longer like I guess, it has or if there's further delays due to expected it anymore advances from Boeing or how does that change that structure.
Whether the reason we got the advance was just to address the working capital issues, because we had already essentially loaded up the plant for 57, Natalie our own material, but also suppliers and so that was really to ease ease that now it depends on when the Max goes back into service what the situation is both.
He has been very helpful. Uncooperative in terms of working with us to figure out what's the right solution turns of production rate and working capital things like that so we'll make the decision once we determine when the Max those back into service.
I would have to be on the impact on rate for us to really justify.
Then he put another bonds because he would impact on phase with the would impact the inventory in our supply chain. So it will then it would have to be beyond ideally it would have to be a decision to change rate.
Okay, great. Thank you.
The next question comes from Carter Copeland with Familiarise Research. Please go ahead.
Hey, good morning Jan.
Hey, good morning.
I'm just wondering if you might help us and good kind of understand the progress. That's that's happened in the Bharti a assets you're acquiring I mean, there are some.
Public financial statements out there that kind of point to a pretty low levels of profitability and yeah. You're obviously looking at a pro forma number three synergies that has a lot of improvement there I wondered if you might give us some color on.
What's happened in those assets at Thats related to volume or changes in cost or onetime items, just to give us a sense of.
The the maturity or what's going on at those assets before you before you take a man.
Right well.
Overall, the good news if you look at the top line.
Especially because theyre, they're getting into some new programs with the 220, starting to ramp up and rate and the Athree 20 thrust reverser not yet even into production as we look out the growth rate is actually quite good.
It's going to exceed 10% on a compound annual growth rate. So so that's very strong the other thing as you look at the aftermarket assets. For example, a very strong margins as you typically see in the aftermarket they've got very efficient operations in Belfast and in Dallas. They do specialized repairs theyve got a great customer base and so the.
Margins in the aftermarket are quite good. The other thing is we talked about business Jets earlier. These are mature programs that they've been building for Bharti a for for quite some time. They still have some crj work. They also have some global express work as well as challenger work and those are at very very good industry margin lever.
Yes, because they are mature and there's a lot of efficiency.
And then as we look forward on to the Athree hundred 20 program.
There's a lot of opportunity to continue improving the margins on that they have their Morocco facility and a lot of work for some especially some of the new packages after winning our plan to be done in Morocco, which has a very competitive labor force very highly skilled labor force and so that's another way to to drive the margins.
And then beyond that.
We talked a bit about synergies and whether its supply chain or engineering or functional.
We see a significant opportunity to bring synergies I mean, this is a structures business, we're structures business, where the largest structures business in the world and so we can bring significant economies of scale to drive synergies as I mentioned, it's 5% cost synergies and a couple points of revenue synergies. So.
That's another way that we can can drive the margins.
And then as I mentioned on the Athree hundred Twentyneo there is no revenues yet.
But that's a new program, it's part of airbus's effort to in source than a sell they've certainly got a strong stake in seen that be successful and we're really pleased to see that the thrust reverser is a part of the work packages in these bharti asset. So just we look across all the programs.
The topline growth is very good and margins are very good and in some of the programs and with the the scale and the efficiency, we bring as a global Aerostructures business.
We'll be able to drive significant synergies to improve the margins further.
The next question will come from Rajeev Lalwani with Morgan Stanley . Please go ahead.
Hi, Good morning, John Good morning away good morning, good morning.
Okay.
All questions around the timeline to the things you laid out today can you provide some color on.
When the center you start to flow and from the been Bharti assets liabilities that you've assumed beyond that payments are going to make with deal close.
When do those have to go out and then on the Boeing side you highlighted the dollars coming in but can you give more clarity around the timeline again of those dollars.
Coming out over the next few years that you highlighted.
Okay, well, let's start with the them Bharti a.
Deal the the synergies really would start immediately upon closing we would be able to start to leverage our supply chain expertise.
And that's how we expect to close sometime in the first half of 2020.
We'll get the synergies really starting immediately I will do a lot of integration work in advance in terms of functional and engineering and indirect cost and labor opportunities and then the supply chain opportunities. So the first full year 2021, we expect to be accretive.
And we'll get probably a third of the synergies that I mentioned, the 5% cost and they've been a percent and a half for 2% of revenue kind of a third per year. In 2020 122. So that's that's kind of how we're thinking about the synergies now the two liabilities that were inheriting.
The pension liability, we're zeroing out the the pension deficit that currently exist states, we start with a clean slate and then we'll work with the union in the pension trustee in the UK and the pension regulator to determine the path forward to mitigate the the ongoing expense of the of the pension.
And so we we have a lot of expertise with pensions in the UK, having dealt with our prestwick site and several people on our team are extremely knowledgeable about pensions.
And we also worked very closely with the Union unite which is in Prestwick and is also in Belfast. The other one is is a series of government loan incentive repayment obligations and these are paid off over time on every 18 to 20 deliberate so the UK government provided incentive funding to build.
Some of the facilities and the capital equipment to enable them to 20 wind to be produced in Belfast and those get repaid over time again once we take ownership will work with UK government to figure out a way to.
Mitigate those and make them the most efficient so we're very confident on that and then Rajiv you said something else about other timing on on Boeing could you just repeat that part of your question. Please.
Well, let's walk right, we've got the advances from Boeing with the lower rates along with working capital. When do you actually have to start paying that back I think and you're right as we said several years or something like that but some more.
It really is tied to when we go back to 57 is what we've talked about with Boeing it's still so we're still working out all the details the what we've agreed as it would be after we go back to rate 57, which could be and to 21 early 22, and then we would pay it off on a on a per unit basis.
Okay. Thank you.
The next question comes from Jon Raviv with Citi. Please go ahead.
Thank you very much I'm, just kind of bigger picture. One question that maybe have some different pieces to over lets you guys go where you want on that one.
You've previously talked about free cash flow margin target approaching 9% is that achievable as you take on these sorts of liabilities, whether it's 77 advances the bumper day items.
Cetera, and I guess embedded in that Israel more specific question around his bombardier cash can be able to keep up with the shelves growth based on maybe some capex cycle there in some new programs ramping up thank you.
I'll take these one.
So so John yes, the that free cash flow target for assay, 7% to 9%.
Obviously, the the acquisition of loan BARDA in the first two or three years, he's going to be heavily dependent on.
Both the eight to two any on the city to any.
Capex demands so it's going to be somewhat dilutive through that 7% to 9% or to the 9%.
The high end of the range, we still plan to be within seven to nine so we'll put it will put pressure on the nine but we think were solidly within the seven to nine.
Now once we get through leasing as investment cycle on these faster growth programs were really on a steady state on both the 220 weighing on the 20. So so I think the capex needs will more than eight and will only be tied to rate.
Similarly to what's happening with our with our core business unit, where.
We see the next two to three years, we filed rate increases.
That's an opportunity to really marketed the topics.
And im get that tailwind on on that.
Well, obviously as part of the integration, we're going to work on working capital.
As we bring our own business here we have.
Very good playbook on.
On these two pay with suppliers were now at 60 days.
We have picked up six to seven days in the last year.
60 basis deal short compared to industry standards. So so we have quite that we the runway there and on inventory we're still on obviously the Mexican founding be than help in 29 team.
So we have a big plan to work already mentality levels on increased turns to the tune off of have how about turn per year in the next few years. So we will we will.
Apply that play will do the integration of.
Over the long by the assets and that will help us from some of the short term capex needs that we see here.
Thank you very much.
The next question comes from Robert Spingarn with Credit Suisse. Please go ahead.
Hi, good morning.
Good morning.
Right.
Tom if if Boeing were too.
Reduce rate again in other words, if this rts just takes a bit longer and they have to go down or whatever the next natural.
Great might be maybe something below thirtys.
Do you drop there or do you dropped below because of your excess inventory. How do you guys think about this I understand it's a draconian kind of scenario, but I imagine you have planned for it.
We have we've run scenarios that all different levels of production.
And it really depends on when the Max goes back into service and how Boeing decides to manage its production schedule. Obviously, we're producing at a higher rate than Boeing right now and so restoring those additional fuselages in a buffer and their their anywhere from say 15 to 25 days before we ship them to two written.
Which is near Seattle.
And so we've run those different scenarios, if Boeing goes down more we would sit down and talk with them about what's the appropriate production level for us that's why we didnt give guidance for the rest of this year, we still don't know when the Max is going to go back into service and.
I will will work closely with Boeing to determine what the right production level is now what I would say, though is that this period of time, where we're at 52.
Gives us a chance to achieve some stability that we havent had for awhile. So going back to 2016, we were shifting from the LNG to the Max we're hiring lots of new people were going up 10% a year a year in terms of our rate from 42 to 47 and 52 than getting ready for 57. So as you can imagine a lot of disruption.
A lot of extra cost as we were going through those learning curves now we're going to be at 52 for an extended period of time, which will allow us to get more stable and allow our supply chain to get healthy and that will mean, knowing more stability, but also opportunities to improve quality.
Which is so important now in the industry, probably more important than it's ever been.
Given that stability is so important is a pause if it's needed better than a lower rate.
Well, yes, I think it is especially with our production system, which is fairly complicated have you I think you've been here to the to the factory and you've seen it.
You know the fuselage itself 33 manufacturing days, there is 450000 fasteners and each one and.
Quite quite intricate and so our our production system gets disrupted if you go up or down and so we take that into account and when we discuss with Boeing is what is the right production level for spirit to be at to make sure that the whole production system operates smoothly and efficiently during this whole period, where the Max goes back.
Into service and Boeing.
Delivers the aircraft that they've already built and not delivered and gets the aircraft that are grounded back in the air.
Okay. Thanks very much.
Thank you. The next question will be from David Strauss with Barclays. Please go ahead.
Thanks, Good morning.
Good morning.
I wanted to Ashu on the.
The margin target the 16.5% I think you had.
Previously said you thought you could get there and in Q4.
It sounds like you're backing off that now on the.
On the seven step downs, which.
I would have thought you would have known about those when you. When you gave the 16 a half so I guess, that's that's the first question, what's what's changed there with regard to Q4.
And then not Tom when you talk about 16.5% for 2020 are you talking about that youre going to get there at some point next year or you expect to averaged 16 at first on across the cross the full year 2020. Thanks, Okay well. Thanks for the question David first of all this quarter. If you look at our normalized margins we.
We're at 16.4%, so pretty close to that target and Q4, we are going to see some pressure from the planned Athree hundred 50 step downs, you're absolutely right. We didnt know that was coming.
We didnt know that we were going to be at rate 52, we had planned originally to be at rate 57, So but the plan is in Q4 as we stabilize is we want to end the year, we want to leave the quarter at about the 16.5% rate it probably won't average that for the quarter, but that's where we want to get to by the end and the goal would be for 2020 to averaged six.
And a half percent absent any purchase accounting that would result from the Bharti acquisition.
Okay, and just a follow up I think you had you had talked about a 5% reduction in fixed cost I kind of achieves this how how far you into achieving the 5% at this point. Thanks.
We're making some good progress we did a couple of things this year to help us move in that direction.
For example, we are.
Taking down contractors and looking at our indirect head count, but one from program. We did this year was a voluntary retirement program a right. After the Max grounding back in April and we would.
Identify 200 people that took that program and it was a good program for them and really helps us start to reduce our fixed costs were going to make a bigger effort on the on the fixed cost I mean, when we're going to go to 57 by backing off to 52, that's basically taking and whats half our revenue down by 10%.
Which means we want to take 5% out of the business, that's where we came up with the 5% number voluntary retirement program to help this year, we did have a furlough.
For 10 days for all of our salaried staff that doesn't repeat next year, but it help this year next year, we will have the full impact for the full year on the voluntary retirement program and then we're going to look hard at our indirect cost and figure out how do we get more productive given that we're going to see this this 5% pressure for prolonged period of time for at least for at least a couple of years.
And so that's what the plan is for next year is to continue working toward that 5% target.
Great. Thanks.
Our next question will be from Myles Walton with GBS. Please go ahead.
Thanks, Good morning.
Well I.
I was wondering could you you have obviously, a nice step down in the price for ASCO has there been any significant change the underlying business there in terms of revenue run rate.
Kind of first as a clarification.
The answer is no the outlook that they've given us for their financials for next year and beyond are still very robust very strong.
And and has the kind of growth that we were originally looking at the cyber attack that hit them in June did require a significant effort to recover and they were down for several days and and they got behind in their production. So they've had to put in some additional.
Resources to recover the good news is they are on their recovery plan their meeting all of their customer delivery requirements and and so theyve gotten the production back on track and what that's done then is enabled them to refocus their attention toward meeting the European Commission conditions to segregate all the data so that we can close the transaction.
But the the financial projections still look very strong and again, it's a great fit lot of Airbus content, there really the leading supplier for the slapped tracks and flap tracks for Airbus. They also have some significant F 35 content. So they bring a lot of military content and then they bring a lot of fabrication capability they've got a guy.
Workforce that has outstanding productivity, good engineering and also a very strong commercial capabilities on fabrication. So it's going to be a nice fit with our business in an all those fronts and.
As I said, the financial outlook still looks very strong.
And then the question I had I don't know foods for Jose some but on triple seven it looks like you're going to deliver.
55 few site or 55, Shipsets this year and that's going spend obviously moving more lower than higher on outlook Im just curious as you've spoken to into 2020. If there were a 10% stepped down from kind of your current delivery pace does that have a meaningful impact on you achieving 16.5% margins for next year.
What is definitely be a headwind.
Triple Sevens and mature program and so margins are better on the mature programs right now when we look at the the skyline, we're still projecting about flat.
In terms of units for Triple seven next year. The obviously the triple seven dash nine is getting pushed out a bit but we're seeing more freighters.
Offsetting that so so from our production standpoint.
We're looking at a flat year next year and Triple seven.
Okay. Thanks.
The next question will be from Ken Herbert with Canaccord. Please go ahead.
Hi, good morning.
Morning, Ken.
Hey, Tom I, just wanted to ask on the Belfast and the when capability there.
What's your contracts with Airbus are you exclusive if they look to do anything larger or with variance on the 220 and then specifically can you. Just you made a comment earlier in the call about sort of incremental opportunity out of this facility with Airbus maybe on other wings for other aircraft can you provide a little more.
Color around that or help with maybe setting expectations on on how that could play out.
Right well, we have the program for the eight to 20 as it is say if they do a variant.
There's no guarantee but obviously as the incumbent and if we continue to perform well we would have a very good position and I think with our engineering.
From spirit and the engineering that they have their in Belfast, we'd be able to provide a strong value proposition.
So so that's on the on the 80 20 as both as Airbus thinks about the wing of the future they've been thinking about composite structures and.
Different technologies, which are out of autoclave like resin infusion and the thing about the wing for they to 20. That's in Belfast is it's a state of the art composite wing that they're already doing now Airbus is going to explore a lot of different options, but the point I was trying to make is that we're gonna have experience with a fully developed state of the our composite wing.
Using out of the autoclave carbon fiber technology resin infusion of for Airbus and that certainly will position us well as they think about future composite wings for different programs and new programs.
Okay, and just just to clarify it sounds like Youre capitals in place in the facility to support rate increases on the a two twentys such that incremental Capex. There is just obviously as necessary maybe support incremental higher rate, but there's nothing else you're looking at near term.
Well there.
Depending on where they finally go on rate there will be some capital expenditures. That's all built into the model and we've also talked to Airbus about what the appropriate sharing level will be on that so we're we're very set on that and there's plenty of capacity in the facility to support the future rate increases that are buses.
Contemplating.
Great. Thank you.
The next question will be from George Shapiro with Shapiro Research. Please go ahead.
Yes so.
Can you explain the difference.
BARDA is saying the assets are carrying values in excess of 700 million and you've got it at 590 million and then also over what time will you pay the difference.
From the 630 to 10, 90 that you're going to pay and last I want to try this synergies one more time. It looks like you know maybe this business makes 9% and you're expecting it to go to 15% pretty quickly I mean.
What would you can you actually be doing that and Bharti I'm sure tried to do to be able to get the margin up that quickly.
Right well the 500 in the 700 is really mostly a difference in terms of U.S. gap versus international financial reporting standards I FRS. So when we had the actuaries value the the pension deficit that currently exist the pension deficit liability.
They use us GAAP accounting and given all of the assumptions in terms of how many people took lump sums and discount factors and all of the accounting technology that went into it the valuation for US on gap was 300 win from BARDA looked at it and their financial condition as much.
Different than ours. So that also plays a factor in terms of credit rating and financial outlook in stability and so when they valued it using their financial outlook and using AI FRS in that gap they come up with a higher deficit liability, which is it's not explains the difference between the 500 the 700.
Now in terms of the time period, the the attention the deficit gets zeroed out at the deal. So so as we start what will be neutral there'll be no net pension liability deficit.
Now going forward, there's a pension and we'll continue to work with the Union as I said, the pension regulator and the Princeton trustee to manage that.
In a safe and and prudent way as we go forward the government loan obligations get paid over time on a per unit based on the eight to 20 is delivered theres a per unit amount that gets paid and then maybe some opportunities for us to front load that or or negotiate different things based on what we're going to do with.
With the assets in Belfast, we've got a lot of ideas for how we can continue to grow those assets. So so that's going to be paid out overtime.
Based on the deliveries of the 220 wing.
Now in terms of the synergies I think I mentioned it before as the largest aerostructures business in the world, we have tremendous economies of scale, particularly in supply chain functional cost engineering and as we bring our business together I think we are probably the perfect fit for this asset I mean, if you look at what they do they do fuselages wings for.
Paulson and aftermarket those are the exact same things that we do and by combining that scale will be able to drive synergies to achieve the economics that we have forecasted.
Okay. Thank you.
Okay. Thanks Gerry.
The next question will be from Hunter K with Wolfe Research. Please go ahead.
Hi, Thanks for getting me on.
The Q2 thousand Shipset deliveries down.
From Threeq Q.
Is that mainly 320 when the I know you guys don't disclose mix was is that mainly through 21, Neos and do you expect to pick back up again in Fourq just base wondering if airbus's is all caught up with some of the problems they have disclosed thanks.
Well I mean, there has been fewer athree hundred 20 ones than in our original plan as Airbus has rebalanced. The line. So we do see some of that impact at we are completely caught up to the schedule that Airbus has given us and the Athree 20 family and I think the issues on production schedule at the.
Airbus level are well known in the market and I think Theyve described those in their communications, so that obviously filters down to the supply chain like us. The only thing a lot is that he told me that will be the timing we need to accelerate some deliveries earlier in the year to build up buffer.
I am split that book potential SXCP issues.
And also on the fed up quite a bit of they have a schedule Holly Airbus, which is closed down a delivery. So I think is adequate but it was just light given timing for the full year, we're going to be where we where we where we plan and were were.
Completely on schedule for the Athree 20 with Airbus.
Okay. Thank you.
Thanks.
The next question will be from Cai von Rumohr with Cowen and company. Please go ahead.
Yes. Thanks, so much so follow up on the acquisitions, so bomb Bharti, you're saying 50 million of cost savings how much of that supply chain, because it's kind of incredible to us. So you get all of that right out of the box and secondly, you taken the price for ASCO down.
So two to 421 point I think you are suggesting that EBITDA margins for like 17, 18% is it still is profitable because if so you're buying at like five and a half times EBITDA.
Yeah, well I'll just take the ASCO one first yes, the price started off it 650, and then we dropped to six so far as the delays continued and not a 420 the outlook is still good and the when you look at the deal economics.
Well, we'll sort those out when we when we finally closed they obviously look a lot better at at the lower rates.
And and so we're we're very pleased with the outlook for that and and the margins look good the revenue growth looks good and they've got great.
Great presence on the F 35 program as well as on all the Airbus programs, even do a little bit of and Bharti work. So that's something that we will look to be growing as we continue to develop the relationship with with somebody a on the synergies just getting back to it the the synergies that we're expecting.
Over the time, it's about 60 million and it's going to be about a third a year over the next three years. After the deal closes and it's going to involve the things I said its supply chain will be a large part of it but they'll also be some opportunities in terms of functions a administration infrastructure in facilities.
So the normal things that you would see but but a big chunk of it clearly will be the supply chain in our industry and structures and aerospace about 66% to 70% of our cost base does come from the supply chain and so that's that's typically where the Sip most significant savings there.
Okay, just but we also see some revenue synergies, particularly in the MRO area and I mentioned that before as you know, that's where it's a little bit opposite they have more scale than us and.
We can bring our customers some of our expertise and.
Some of our.
Tooling and benefit on the revenue side on the MRO.
Just a quick follow up on the ask why would a seller give you.
30% discount on price if the outlook was still the same are the margin targets still pretty much the same.
Margin targets Havent changed materially based on the leave financial projections that we have we'll get into more detail. Once we once we close.
This deal has taken longer for for both parties I think both parties recognized that it's taken longer in costs more and so we we explored various different structures with the seller and agreed that this this new price was the thing that just work best for both parties. So.
So again as I said, we're still.
Very very excited about the strategic fit of Vasco and the financial outlook still looks good.
We collaborate very well with Christian Boaz who's the the the the owner right now along with the siblings and he's a CEO and.
We're looking forward to working with them. After we close the steel he he brings tremendous expertise in the in the fabrication area and we think we can continue to grow the business with that assistance.
Thanks, so much.
The next question will be from Peter Arment with Baird. Please go ahead.
Yes, Thanks for squeezing me in a good morning, Tom has anyone and Tom.
Maybe just a clarification given so much detailed on the Mardi deal probably too early for pinpoint number but have you sketched out what you expect for intangibles on this transaction. Thanks.
We have not I mean, we're gonna we're gonna. This study integration planning here shortly and we look at a time.
What's there in terms of allocating value x's value to intangibles versus would wheel.
We do have.
An opportunity to.
Who is concurrently to the ASCO.
So we have experience assessing that.
And we will plan to adjust adjust adjusted to earnings.
Once the deal closes and we've looked at.
Just on there seems to be and we've seen that most of our beer suggests intangible amortization to earnings. So that's kind of our our first pass although it was doing to conclude on that on a decision.
Got it and just as a quick follow up Tom just obviously, you expect Tabasco to close long time ago.
Just a it looks like both these deals going to be closing pretty much around the same time.
Just thoughts on that just handling it from just being management stretched and thanks, right well you're right. They could converge because the ESCO deal has has taken longer than we expected, but we'd be happy for both of them to close a in the first half of next year.
So in terms of of management bandwidth of course, it's always a challenge when you're integrating a big acquisitions like this but these are different teams. The ASCO part of the business will be part of fabrication and we have a global team.
Led by a gentleman named Kevin Matthijs, and and so he will be responsible for integrating the ESCO assets. The the BARDA assets are really Airbus focused.
And it will be run by our Airbus program, which is based in Europe . Scott Mclarty is the Gentleman's named he is based in Prestwick has a lot of experience in working with Airbus and working in the UK and with the unite union. So it'll be good fit so so it'll be a lot of work, but the teams that are working.
Got it will be very different teams and we'll be able to divide and conquer and integrate both of these successfully.
In the interest of time, our final question today will be from Michael Similarly, with Suntrust. Please go ahead.
Hey, good morning, guys. Thanks for us to grow purging, just maybe maybe one more time to hit US Carter's initial question in Georgia is on on the margins at the bombarded assets you know they've got a lot of aftermarket.
Lower margin aftermarket is that more services, just just trying to get a sense of why the margins are currently so low I mean, you know is it is it more new start programs. If there's still a lot of development. There. Just you know maybe if you can give some specific as to why there.
Margins right that 910% level.
Right well its structures and you've got two programs that are really in startup mode. The eight to 20 wing and the and then the Threetwenty thrust reverser. So yeah. Those are our programs that as they mature will naturally be able to improve margins and particularly as we can bring synergies.
To them so.
So so thats I mean, I think thats. The the main reason that you see some of the challenge the the Bharti eight programs the business jet programs is here Jay So those are mature the margins on those tend to be tend to be pretty good aftermarket is really they do some spare parts, but what they do is a lot of.
Structural MRO, particularly around thrust reverser, so very similar to the things we do a lot of that is extremely sophisticated work. The margins are quite good on that and and we see a lot of opportunity through revenue synergies to to grow that business at a faster rate than it was growing before and as I said it doubles our aftermarket.
And makes it a lot more significant contributor to our to our economics going forward.
Got it helpful. Thanks, guys.
Ladies and gentlemen, this concludes our question and answer session and thus concludes todays call. We thank you for attending Spirit Aerosystems Holdings incorporated third quarter 2019 earnings Conference call. You May now disconnect your lines take care.