Q1 2022 Spirit AeroSystems Holdings Inc Earnings Call
Items are a small percentage of our overall costs, we are working to offset the increases.
One of the ways, we work to mitigate inflation and our supply chain is through long term agreements and.
In some cases, our agreements with suppliers go out to 2033, which matches the term of our pricing contract on the 737, Max with Boeing providing a natural hedge to help mitigate short term inflationary pressure.
In terms of pricing most of our customer agreements have clauses that help address both labor and material inflation and provide the ability to offset some of the increase in costs.
As we start to produce at higher rates, we are beginning to see signs of stress at some of our suppliers.
Skilled labor availability and challenges with OEM qualifications and approvals are leading us to take actions to us.
To secure part supply in order to maintain a healthy production system.
Dan will go over a few more details in her remarks on how we are addressing supply chain issues.
Despite the challenges we have faced we remain sharply focused on progressing our three key priorities.
Diversifying our revenues delevering of $1 billion over three years and driving margins to 16, 5% target.
Our Belfast site is a key contributor to our diversification efforts are Airbus work packages increased significantly from this acquisition with the addition of the <unk> hundred 20 integrated wing and center fuselage and strengthened spirit's position as one of the top external suppliers to Airbus. We also became a top supplier to <unk>.
Bombardier with the addition of significant business jet content on the Challenger and Global Express.
One significant development recently is that we reached an agreement with the United Kingdom's Department for business energy and industrial strategy to retire the launch investment associated with the <unk> hundred 20 program earlier than planned Mark will go into more details on the financial transaction in his remarks.
In early April working with our two Belfast Union partners. We also negotiated a new pay agreement that covers more than 2000 unite and GMB represented employees in Belfast.
The mutually beneficial arrangement, which runs through December of 2023 is an important element in our commercial segment's future.
On the 737 Max program, we are just moving to a production rate of 31 aircraft per month, and our planning right now to stay there for the rest of the year. Our expectation is that we were produced 315 737 Max units during 2022.
Given what Boeing has communicated about their production rate it.
It will now likely take longer than we originally expected to reach a permanent buffer of 20 units of the Boeing owned inventory in Wichita that will help cushion the production system in the future.
Turning to the 787 program. We are currently expecting to deliver about 20 units in 2022, a reduction in schedule, which contributed to the forward loss this quarter and created some headwinds to inventory on the program.
On Airbus programs, we are generally in line with expectations for the year.
Airbus remains extremely bullish on demand for the <unk> hundred 20, and the <unk> hundred 21, and plans to hit the production rate targets that they have communicated publicly on.
On the <unk> hundred 50, we have begun engineering work on the new freighter, which Airbus has announced for entry into service in 2025.
Our defense and space business showed solid growth in the first quarter and we expect to see that growth pick up in the back half of the year as current programs mature.
The defence and space team had some great wins in this quarter included including winning the development contract announced by Boeing to support the B 52 commercial engine replacement program.
We will be responsible for the engine timelines and the cells on this program and interesting note is that all of the B 52 Hs currently in service today were built in our Wichita facility.
We are excited to support the B 50, twos mission for many years into the future.
We have a strong defense and space pipeline, which is almost entirely focused around department of defense programs that are currently in development, but not yet fielded offering significant long term upside to our defense and space business.
Our aftermarket business also had a very strong first quarter growing 52% on the top line and delivering 23% margins. The team achieved this growth even after offsetting the loss of <unk> 21 aftermarket revenues.
Our aftermarket team has also been aggressively pursuing new opportunities.
Last week Boeing Global services selected spirit as their partner for 737, Max Nacelle and flight control surface repairs.
Our efforts to build a global MRO footprint enable us to serve boeing's customers around the world with industry, leading turnaround times.
We were also pleased to announce a new partnership with Guangzhou aircraft maintenance Engineering company also known as <unk> to serve as an authorized repair center in China.
I will now turn it over to Sam to describe how we are driving productivity rate readiness and growth in our commercial segment Sam. Thank.
Thank you Tom.
We've seen some challenges in the first quarter. However, we are positioning ourselves to benefit from the air traffic recovery that appears to be gaining strength.
Domestic air travel improvement in many parts of the world is driving narrow body demand will be favorable to spirit is approximately eight 5% of our backlog is tied to single aisle aircraft.
With that in mind, we remain focused on execution.
The narrow body production rates recently increased and were now producing the 787 at a rate of 31 per month.
To date, we've been able to test a recall lift in order to meet all of our staffing needs.
In Wichita, we just recently issued the final vehicle, but those that were furlough during 2020 and by recruiting new employees for future staffing needs.
Richard has a strong aviation labor pool of talent.
Control.
The implementation of Digitization and not to make mention projects to drive productivity is tracking to plan, which will support higher rates and improved commercial segment margins in the future.
I'll now Airbus programs. We also have the staffing in place to meet the right requirements Airbus has requested.
We're also working closely with our suppliers to support their rate readiness.
Just like the rest of the industry our supply chain is experiencing some challenges.
Examples of the types of support we are providing to assist include logistics raw material sourcing and inventory management.
And in some cases, we are also extending contract terms with the suppliers have demonstrated excellent performance with.
We're fortunate to have a world class supply chain and fabrication team that can work with suppliers to mitigate risk and even blue streak. They needed in some cases, we're also dual sourcing some costs to mitigate risk.
Our commercial team is also focused on growth this quarter, we announced that we signed an agreement with Airbus for the development of the city Atlas Nexgen prototype.
They are responsible for developing and manufacturing the aircraft's wings and supporting emphasis exploration of disruptive aircraft design.
We are also actively exploring other options to support the emerging <unk> market.
In addition, as Tom mentioned, we have begun work on the Airbus <unk> hundred 50 freighter, but.
That I will turn it back over to Tom.
Tom.
Thanks, Sam as expected the first quarter has been a challenging one on cash attributed partly to the additional working capital we consumed to support the rate break to 31 aircraft per month on the 737 and the increase in rate on the <unk> hundred 20.
When those programs stabilize at higher rates, our cash position will continue to improve throughout the year. As we have previously communicated we will be repaying Boeing $123 million this year for <unk>.
Advance on the 737 program in 2019.
Given the current outlook, we now expect an additional $50 million to $100 million of pressure for all of 2022, which means that we expect cash usage for this year to between to be between negative 175, and negative $225 million Mark will now take you through the details of our financials for the first quarter results Mark.
Thanks, Tom and good morning, everyone.
As we discussed on last quarter's call, we anticipated the first quarter financial results would be the lowest of the year with meaningful improvements in the second half of 2022.
Driven by increased narrow body deliveries, specifically, the 737 and <unk> hundred 20 programs.
We expect to see this reflected improvements to our deliveries revenue margin and cash flow throughout the rest of the year.
At the start of 2022, we like many others around the world experienced surge in Covid, 19 cases, which created some unexpected pressure.
Our case rates have declined in our factories other parts of the globe continued to be adversely impacted by the pandemic, adding to near term uncertainty.
Then the Russia, Ukraine conflict began which created additional challenges, including the procurement of materials and the exacerbation of inflation that we were experiencing.
These pressures along with the supply chain disruptions and customer schedule changes have impacted our business and we are aggressively working on initiatives to help mitigate those impacts.
Now, let's move to our first quarter 2022 results.
Please turn to slide three.
Revenue for the first quarter was $1 2 billion up 30% from the same quarter of last year.
This improvement was primarily due to higher production on the 737, <unk> hundred 20, and <unk> hundred 20 programs as well as increased aftermarket revenue.
These increases were partially offset by lower production on the 787 program.
When we look at deliveries the narrow body programs in the first quarter of 2022 were 36% higher as compared to 2021.
With 233 in the first quarter of 2022 compared to 171 deliveries in the same quarter last year.
737, <unk> hundred 20, <unk> hundred 20 programs each had increased deliveries.
The first quarter 737, Max deliveries were 60 units compared to $29 in the first quarter of last year.
Wide body program deliveries were down 21% to 38 units compared to <unk> 48 in the first quarter of 'twenty one.
Driven mainly by the 787 program.
Overall deliveries increased to 321 units compared to 262 in the same period of last year.
Now, let's turn to earnings per share on slide four.
We reported earnings per share of negative <unk> 51.
Compared to negative $1 65 per share in the first quarter 2021 adjust.
Adjusted EPS was positive <unk> compared to negative $1 22 in the same period last year.
2022, adjusted EPS excludes the deferred tax asset valuation allowance.
2021, adjusted EPS excludes costs related M&A restructuring as well as the deferred tax asset valuation allowance.
We focus on operating margin, we saw improvements to negative 4% compared to negative 14% in the first quarter of 2021.
Reflecting increasing production rates and lower costs associated with excess capacity and changes in estimates recorded during the current period compared to the same quarter last year.
Ford losses in the first quarter of 2022 or $24 million, primarily driven by further production rate decreases in cost of rework on the 787 program.
As well as increased cost of quality and production rate increases decreases on the <unk> hundred 50 program.
Unfavorable cumulative catch up adjustments totaled $26 million and were driven by increased estimates for supply chain raw material and other costs on the 737 program.
In comparison during the first quarter of 2021, we recorded $72 million of forward losses, driven by lower production rates on the 787, and <unk> hundred 50 programs and $6 million of unfavorable cumulative catch up adjustments.
First quarter 2022 earnings included $50 million of excess capacity costs, a decrease of $18 million for the same period of 2021.
As well as abnormal costs related to COVID-19 of $10 million, an increase of $7 million over the first quarter of 2021 due to the impact of the COVID-19 cases.
That hit us at the beginning of the year.
Additionally earnings included $33 million related to the aviation manufacturing jobs protection program, which was awarded during the third quarter of 2021.
Other income for the first quarter of 2022 was $25 million.
Better than the same period last year, resulting mainly from foreign currency exchange gains.
Now, let's turn to free cash flow on slide five.
Free cash flow usage for the quarter was $298 million.
Historically first quarter free cash flow has always been impacted by the seasonality of cash receipts related to the year end annual holiday shutdown as well as employee benefit related payments.
Cash usage was $100 million higher this quarter compared to the same period of 2021.
Driven by higher working capital due to increased production activities as well as quarterly cash repayment of $31 million related to the Boeing 730 advance we received in 2019.
We also made a payment on the repayable investment agreement with the UK Department of business energy and industrial strategy and $15 million of that payment is reflected within free cash flow.
The surge in COVID-19 cases at the beginning of 2022 resulted in cash outflows of.
$10 million.
Then to address the conflict in Russia, and Ukraine, we added additional inventory, including titanium to mitigate potential disruptions to our production system.
During the first quarter of this year spirit received $14 million.
Of the AAM JP program Grant awarded in 2021, and the remaining $24 million is anticipated to be received.
In the remainder of 2022.
Looking ahead, the recent downward revisions to production schedules for some of our programs, we will add additional pressures specifically on earnings and cash related to the 737 program and slower inventory burn down than previously expected on the 787 program.
Given the customer schedule changes supply chain disruptions, Ukraine, Russia conflict and inflationary pressures. We are now expecting full year 2022 free cash flow usage to be between 175 million to $225 million inclusive of the $123 million Boeing advance repayments.
This reflects estimated capital expenditures of $150 million to $175 million.
With that let's turn to our cash and debt balances on slide six.
We ended the quarter with $1 2 billion of cash and roughly $3 8 billion of debt.
In April we reached an agreement with the Uk's Department of business energy and industrial strategy to retire the outstanding Repayable investment agreement, which we acquired as part of the acquisition of selected assets of Bombardier in 2020.
This resulted in a cash payment of $291 million made in April .
This transaction will be reflected in our second quarter 2022 financials.
I would add that this will reduce interest related cash outflows annually and into the future.
Now, let's turn to segment performance and we will begin with commercial on slide seven.
In the first quarter of 2022 commercial revenue increased 35% compared to 2021.
Primarily due to higher production volumes on the 737.
220, <unk> hundred <unk>.
Partially offset by lower production on the 787.
Operating margin for the quarter increased to breakeven compared to negative 12% in the same quarter of 2021.
The improvement in operating margin was due to higher volumes on the 737 lower excess capacity costs lower changes in estimates as well as income related to the.
<unk> program of $28 million.
<unk> recorded a $26 million of net forward losses, and $26 million of unfavorable cumulative catch up adjustments during the first quarter of 2022.
In comparison.
During the same period of 2021. This segment recorded $68 million of forward losses, and $8 million of unfavorable cumulative catch up adjustments.
Now, let's turn to defense and space segment on slide eight.
Defence and space revenue improved by 3% compared to the first quarter of 2021 due to increased production and development program activity.
Operating margin for the quarter was 13% compared to 8% in the same quarter of 2021.
The improved operating margin was driven by solid execution favorable changes in estimates and lower excess capacity costs compared to the prior year.
The segment recorded excess capacity cost of $3 million and favorable forward loss adjustments of $2 million compared to excess capacity costs and for losses each of $5 million in the first quarter of 2021.
For our aftermarket segment results, let's now turn to slide nine.
Aftermarket revenues were up 52% compared to the same period of 2021.
Driven by higher spare parts sales as well as higher maintenance repair and overall activity operating margin for the quarter improved to 23% compared to 21%.
The first quarter of 2021, driven by favorable product mix recognized during the first quarter of 2022.
Our aftermarket team continues to win new business and we are excited about the growth potential of this segment.
In closing the recent downward revisions to production schedules for some of our programs will add pressure specifically on the 737 and 787 programs.
We are also facing supply chain disruptions as well as geopolitical and inflationary challenges that are putting pressure on freight utilities and logistical costs.
The Russia, Ukraine conflict has caused us to strategically increase of material inventory to minimize production pressures down the road. Although these challenges will have an impact in the near term.
We remain focused on positioning ourselves to benefit from air traffic recovery and we are.
Remaining focused on execution and preparing for the various rate increases that we'll see in the coming months now lets turn over this back over to Tom for some closing comments. Thanks Mark.
<unk> team has responded well given the challenging circumstances, the commercial business will continue to benefit from the narrow body recovery in future rate increases the 787, Max programs increased to 31 aircraft per month.
As an important milestone and we expect to sustain that rate through the remainder of the year.
<unk> hundred 20, <unk> hundred 20 programs continue to be in sync with Airbus and we remain on plan to achieve increased production rates that Airbus has announced.
Our diversification efforts had solid progress across all three segments. The commercial segment secured an important work package on the new Airbus E. VTOL aircrafts, our defense team one work for the B 52 commercial engine replacement program and the aftermarket business announced partnerships with Boeing and Gamco.
As we expected the first quarter was a challenging one.
The narrow body production rates stabilize on the Max and increase on the <unk> hundred 20 throughout the year. Our financial results are positioned to continue to improve with that we'll be happy to take your questions.
Thank you everyone else does have a Q&A session.
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Ask your question. Please ensure that your line is on mute lately.
And our first question comes from Robert Spingarn from Melius Research. Please go ahead. Your line is open.
Good morning.
Good morning, either Tom or Sam I wanted to ask you about inflation risk either in your fixed price contracts or contracts were protections may not keep up with inflation and then as part of that how should we think about your upcoming expiring machinist contract next year I think you'd cut.
Average about 6000 people and how might that factor into.
Your future costs and your ability to hit the 16, 5% margin.
Right well on inflation.
Obviously lots of different contracts and all of them are are somewhat different but typically on on the Boeing contracts the way inflation and escalation works is.
That we absorb the first amount up to a threshold and then we split it above that.
But in both of the Airbus and Boeing examples.
They are responsible essentially for the raw material costs and so.
We have these buying consortia that I mentioned <unk> extra bowling combat for Airbus and they take care of buying all of the raw materials for their respective programs and and that helps us protect against that mitigate inflation as I mentioned, we also have long term agreements in place with a lot of our suppliers.
That go out as far out as our Max pricing contract for example to 2033, which creates a natural hedge. So those are some of the ways that we mitigate inflation and the way our contracts work.
With regard to the I am the contract is due in June of 2023.
We extended that in at the beginning of 2020 and.
And we've already been in discussions with our Union partners about that and we'll continue to work with them in anticipation of that.
We have taken into account that.
That contract as we think about our long term projections and the 16, 5%.
So as I've always said in this industry you have to run fast to stand still and even though we're driving productivity and supply chain and in our factory operations. We have headwinds in terms of labor increases raw material increases other inflation in things like logistics or utilities, and so we have to offset all of those in order to achieve the 16, 5% and we are.
Taking that into account as we make those projections.
And I guess, the price step down as well on the <unk>. If you get if you get about 42.
Yes, we've taken that into account as well.
Okay. Thanks, Tom because don't forget when when production goes above 42 will be obviously, delivering a lot more units and generating a lot more revenue and total profit dollars, even though we.
The pricing goes into a discount once we go above 42.
Right. Thank you.
Perfect. Thank you so much Robert for your question. Our next question comes from Seth <unk> from Jpmorgan. Please go ahead. Your line is open.
Okay. Thanks very much.
Good morning.
So again, a little bit more on this question.
737 profitability.
Can you tell us how.
How large.
The block size as for the 737 right now.
And how much of it is.
Good evening.
And then.
I guess.
To the extent that you have seen these cost pressures.
How do you think about how enduring name I E versus how much of them are tied up in potentially.
Temporary shortages of certain material.
And.
I will leave it there and with those two.
Seth why don't I jump in and then Tom can add some some color here.
Our current accounting contract and the 737 that we just started here in April .
It is roughly 200 chipsets.
And so that's the that's the typical size of our 730 accounting contracts, which are which are tied to purchase commitments.
By our customer.
Just a couple of comments from me obviously, when you think about US holding 31, a month through the rest of the year.
The majority of that contract should end and up and close out before we get through the rest of the year. So any near term inflation could put pressure on the 737 margins as we think about 2022.
And.
We're seeing it I mean, it's obvious the month of March we looked at.
Inflationary measures eight 5% and so significantly higher sustained inflation over the next several months or the course of 2022 could put.
Some pressure on labor costs and other costs that we mentioned, but we're working hard on it.
Rate increase from 21% to 31 is significant it's a 33% production rate increase that will have a significant help on the revenue earnings and will also absorb.
Our overhead costs and significantly reduce excess capacity costs. So we're looking forward to it we're delivering at that rate. Starting this week. We're excited the production system is is ready for it we invested heavily we made some decisions in the first quarter.
To make sure that we protected our 31, a month rate increase and.
So where that thing.
That's where kind of things stand here in the near term.
Yes, I would just add to that you asked about cost pressures. This year most of our costs are really already locked up in long term contracts with our suppliers and then we have our customer contracts and so in terms of raw materials and detailed parts.
Those are already locked up and as we just talked about our labor contract with our biggest union goes through June of next year. So so those are all fairly stable as were looking at this year, where we see some inflationary pressures if we have to buy some commodities on the spot market incrementally or in some things like utilities and logistics.
And those are subject to some increases but as I said in my in my comments. It was a relatively small percentage of our total cost.
Even though we're seeing some inflationary pressures so I would say overall the cost pressures are mitigated just because of the long term contracts that we have in place.
Okay, great. Thank you very much.
Welcome.
Perfect. Thank you so much for your question.
Our next question comes from Ken Herbert from RBC Capital markets. Please go ahead.
Yes, hi, good morning.
Tom or Mark I am wondering with the change in the free cash flow guide and the incremental cost.
Can you just talk about the key moving pieces sort of between the.
The upper end of the lower end of the guide now for this year and what's changed obviously over the last few months. So as you think about where the sort of incremental risk, but sort of the.
What's helping to bracket the range there and the key pieces in the range.
Yeah, Ken I'll start the first thing is we have had some schedule changes from a customer specifically on the seven.
787 has come down as Boeing continues to work through getting it back into delivery. The other is on the 737 earlier in the year, we were looking at scenarios, where there might be yet another rate break. This year. We don't anticipate that now we expect that we will stay at 31 for the rest of the year. So so those were a couple of initial.
Headwinds.
Other is as we've been discussing some supply chain disruptions, we're having to help some suppliers that get into distress with raw material purchases or onsite support or moving parts as the case may be so that.
It's a challenge we have had some raw material buy heads, especially on titanium.
To secure some stockpiles and make sure we had adequate supplies.
That was about $10 million in the first quarter, but we felt that was a good investment to protect the production system.
Mark mentioned January with the Omicron variant.
Particularly heavy.
In January and that created about $10 million of pressure and then as I mentioned, some inflation on logistics and utilities. So all of those things are going to drive that additional $50 million to $100 million of headwind that we said now we're going to continue to work on that but we just wanted to give everybody the outlook that right now we're looking at negative 170.
Five to negative $2 25 for the quarter or for the year, which includes the $123 million payment to Boeing.
Great. So just to clarify that.
Delta between potentially the 50 or 100 incremental use it sounds like that risk is really supply chain is you should feel pretty good about visibility on Max and 787 now.
That's correct.
Okay, great. Thank you.
Thanks.
Perfect. Thank you so much for your question.
Next question comes from David Strauss from Barclays. Please go ahead.
Thanks, Good morning.
Good morning, good morning.
So Tom.
Tom I just wanted to follow up on the on the Max comment because I guess I guess I'm, a little confused because I think before.
Yes, sure I guess today now youre talking about 315.
Units delivered production to Boeing this year and I think before you had kind of implied a similar level.
Without specifically, calling out the actual number but you certainly implied something in the low 300 range, but you are signing these downward revisions to match rate as a as a reason for taking down the free cash flow forecast. Thanks.
Yes, well as I mentioned earlier in the year at the last earnings call. We thought there might be yet another rate increase this year.
Now don't think that'll happen and we're going to be at the 315 level for the year as we stay at 31 aircraft per month for the rest of the year, So thats really the situation.
And any ex figure what I guess, what is the expectation now in terms of.
Drawing down your buffer inventory from I guess, it's currently around 100 down to that 20% level.
Do you think the timeframe is on that now.
Yes, well its currently about 85, it's been as low as 75, but it's bouncing around a little bit and I expect it's going to kind of plateau here for a while while we are at the same rate as Boeing and <unk>.
So it's going to take longer I expect it's going to go now into next year before we get down to the 20 level don't know exactly when it depends really on when Boeing increases their production rate above the 31, and we start to burn that down.
Alright, thanks very much.
Youre welcome.
Thank you so much our next question comes from <unk>.
Sheila <unk> from Jefferies. Please go ahead.
Hi.
Good morning, guys. Thank you just sticking to the Nash Macquarie.
When we think about the Max at 31, a month they bought for 'twenty two how do you see that going up potentially in 2018.
Tom do you think that could be or Mark do you think that could be potentially a supply constraint right. You don't have the inventory available or the labor available or a demand constraint like what what do you think about that question is if youre eating 75% of the cost.
Yes on those contracts like how do you think about how you negotiate that.
Right well first of all we.
We don't know what the rates will be in 'twenty, three yet Boeing hasn't communicated that and so we'll wait to see.
With regard to supply we don't anticipate any supply constraints, we have some disruption in our supply chain, but we are mitigating it.
One thing that we have is we have a very strong fabrication operation, we make over 32000 parts ourself.
And we have a lot of what we call Blue Street capabilities of supplier gets into trouble. We can quickly manufacture that part many of the parts, we use to manufacture ourselves and things always are moving in and out of our own fabrication shops. So so there is no constraint in terms of supply and meeting any production rate increases in the future.
And we'll wait to see from Boeing what those will be but for right now we're expecting we're going to be at 31 for the rest of this year.
Okay. Thank you.
You're welcome Thank you Sheila.
Thank you so much.
Our next question comes from Doug <unk> from Bernstein. Please go ahead.
Good morning, Thank you.
Good morning.
Uh huh.
On the.
On the 16, 5% margin and this has been tied tied this to the <unk> 42, a month rate on the Max but can you talk about what is also implied in terms of assumptions on your other programs to get to that 16, 5% margin and the <unk> hundred 50 787.
How do you get to that number.
<unk> <unk>.
The Max goes as you would expect.
Yeah, Doug well for one as you know Max still is a major driver of our overall economics and so we just used 42 aircraft per month on the Max as a surrogate for kind of long term stability, but we're also just assuming more or less with the Oems have communicated publicly in terms of their <unk>.
Production rates. So for example on the 787, we tried to give you some indication right now for this year, we're looking at 'twenty, but once Boeing starts delivering it again, they will increase the rates and those are the kind of assumptions that we've incorporated into our long term planning on the margin and on Triple seven Boeing made some announcements in terms of a day.
Les on the introduction of the Triple seven X.
But some of that will be offset by freighters in the near term. So we haven't really changed any assumptions on the triple seven and then on the Airbus programs. We're really just in lockstep with where Airbus has communicated.
For example on the <unk> hundred 20, they've said, they're going to be at 65 by mid of 2023, and so that's what we've incorporated in.
On the <unk> hundred 50, they're planning to get up to about five or six aircraft per month as they get into 2023. So that's what we've included in on the <unk> hundred 20, we're right now at about between five and six aircraft per month, and they're planning to get to 14 by the middle of 2025, so those.
Those are the basic assumptions that we have built into that 16, 5% projection, but again the biggest driver is going to be the Max and what we've said is when we get to 42 at a sustained.
Right is that when we think we can hit the 16, 5% margins.
And on the mix when you talk about the 31 a month through the rest of this year what is the what's the typical lead time in terms of the signal in other words, if you were going to be looking to go a break up to let's say, let's say 42 at Boeing.
How far in advance do you typically get that signal.
And are able to react to it.
Well typically it's six months, but theres nothing typical about the last couple of years.
We've had a much shorter lead times for both increases and decreases so look we've got to be agile and we've got to work with Boeing based on the market.
So and we are going to be agile and we will listen to both them and Airbus and make sure we're ready to deliver on what their requirements are.
Okay, great. Thank you.
Youre welcome.
Yes.
Thank you so much. Our next question comes from George Shapiro with Shapiro Research. Please go ahead.
Yes.
Mark I wanted to ask is if I take out all of the kind of excess costs in the AMG JP in the quarter. The underlying margin in commercial was about 8% I know you don't take out excess costs. So you would be around 3% going forward for the rest of the year how would you.
Expect that number to change.
Well thanks for the question George.
I think we've talked about this in the past.
As we talked here, we're now producing and delivering it at 31 aircraft per month on the 737 program, which was our strongest performing program.
And when you think about the lift from a financial standpoint.
Obviously, we're going to have the revenue, but we would expect that 33% production increase.
On an incremental basis to help help our margins help or help our profitability specifically on their program by somewhere in the ballpark of 25% to 30%.
Okay. So the incremental margin youre, saying that would be 25% to 30% okay.
Yes.
Okay.
And the other question just probably a minor one but the tax rate of 17% this quarter to the same high to me.
And that had the deferred tax valuation was higher running a little higher than we'd run some last year. So can you just explain what's going on between the deferred tax asset valuation and the tax benefits you got this quarter.
Sure George.
The nuances of tax.
Get a little complicated, but let me just try to walk you through that when we look at our tax rate.
The old tax rules, where you looked at your.
Actual performance in the quarter and you recorded your tax rate based on that we.
We have to look at our tax rate our effective tax rate based on a full year expectation of earnings and so if we're in a situation and this is just call it.
An example, if you lose money in the first quarter, but make money in the back half of the year.
We have to then smooth out the overall earnings the pre tax income over the course of the year and that can drive some real.
Significant variation as it relates to what you actually booked from a tax standpoint compared to what your true pre tax income is so although it looks at normal I understand why you're asking that the new rules expect for us to kind of look at it over the course of the year and then normalize the tax.
Right on a quarterly basis, and so as we move through the course of the year on our earnings.
Start to recover as we generate more revenue youll see that normalized tax rate, excluding the tax valuation reserve.
To make more sense to you.
Okay. Thanks very much.
Thanks George.
Thank you very much George for your question. Our next question comes from Kristine <unk> from Morgan Stanley .
Please go ahead, hey, guys.
Hey, guys following up on the 737 negative cumulative catch up I mean should we think about that $26 million over the 200 airplanes in the accounting block because if we take that per unit. It sounds like that's about 2% margin headwind for the 737 is that how we should think about it or is there something else we should consider.
Let me, let me jump in here Kristine and then.
Tom May want to add to that.
Really what happened here.
Unfavorable Q catch up is related to our accounting contract that just closed at the end at the end of the first quarter.
And as you as we are building and establishing our production system to support 30 or 31 aircrafts per month, there were costs that we incurred in the first quarter.
Supply chain disruption costs, some dual sourcing some.
Some cost incurred from an inventory standpoint to protect ourselves. So that we can seamlessly take that rate increase from 21% to 31 and that added.
At least half of those costs were supply chain disruptive disruption type cost that ended up in the block and caused the pressure.
In the accounting contract that just closed now as we move forward here and we were at the higher rate.
We've worked through some of those supply disruptions it doesn't mean that.
Our supplier supply chain is in perfect health, but those were costs that we incurred in the first quarter to protect the production system and then as we move forward.
Into our current accounting contract, which we are delivering now we should see that supply chain disruption cost mitigate or minimize as we move forward at the higher rate. So it's really contained on our previous accounting contract and I wouldn't expect a significant amount of that to recur.
And it's our job to kind of manage through those challenges and protect our profitability. So again it was protect our production system protect our production rate.
If we don't do that well.
That would cost us a lot more than the $26 million.
Yes, that's really helpful. Thank you for the color and if I could follow up on the Max production rate last quarter, you guys talked about producing at a five chipset right.
<unk> allow inventory burn off can you help us understand what's changed and why 31 per month is now the 2022 production rate I would have thought it'd just be a little lower.
Right well.
This has been in the plans for a while and.
I think Boeing wants to make sure that its supply chain is stable and it had already given us a signal. So we have gone up to the 31 as planned they are staying at 31 now and so we're going to be at the same rate for longer. So it means the buffer will get burned out but the good news is is that we have the agility to manage those trade offs.
In order to preserve the production chain health and so Thats, what Boeing has decided to do and we're in we're matching it but thats. What happened is we've been planning for this break to 31 for a while.
Boeing has asked us to continue to do it even though they're going to stay at 31 as well.
Okay, Great and then in terms of your and protect the overall supply chain.
And just I guess for the free cash flow lower guide for the year is that factoring in just a lower burn off of your inventory then.
No no Kristina if youre talking specifically on 737.
We were expecting.
A tick up in production rates in the fourth quarter.
And our current schedules and our current expectations, we don't see that happening.
So as a result of that.
There'll be lower revenue and earnings on the 737 program, which is going to cause lower lower cash flow than we previously expected now on the positive side is we're going to be staying at 31 for a longer period of time, we're going to drive a lot of stability and continue to work on our our production system improvements.
And I think we're going to see a lot of benefits as it relates to stabilizing at 31 months, helping our supplier stabilized at 31, a month before we aggressively go back up in rate. So I think near term.
It's a little less revenue little less earnings in cash, but I think over the long term and we've got to think about our business long term, we're a long cycle business right I think over the course of the next 18 months to 24 months. This is going to be positive for spirit and for our suppliers as well as Boeing that we stabilize the production system, we get on a step.
Drumbeat right and.
That higher rate is good for us we're going to generate more revenue and earnings will drive stability will work with our supply chain and I think that will better prepare us for the next rate break when it comes.
Great. Thank you very much.
Thanks Christine.
Thank you guys. Thank you for your question. Our next question comes from Myles Walton from UBS. Please go ahead.
Thanks. Good morning, just wanted to put a little bow on the 77 production rate dynamic is it fair to think that you were previously assuming Boeing is going to liquidate previously booked revenue 787, Max's and you were previously assuming that there was going to be another rate hike in the back half of the year. So presumably you were thinking Boeing is going to get it.
Right above 40 before the end of the year.
Now.
Basically if theyre going to stay at.
<unk> 31, and Youre not to liquidate inventory is that the the short of it.
Well first of all it is.
Our inventory because we've already delivered those units to Boeing and we're just storing them here in Wichita.
But just to answer your question is yes, we did expect a rate increase in the fourth quarter as Mark said and we don't expect that now and so thats the major difference.
Andrew were noted to liquidate.
The units you had booked revenue against but we're sitting in Wichita.
Correct, we expected that to burn off and now it's going to be a slower burn rate, we expected higher and we expected to burn off at the end of the day, we really can't opine on Boeing's production system right now the systems are pretty disconnected, what Boeing delivers what we produce what we're really focused on is.
What is our requirements what are we deliver from and at the end of the day Boeing will deal with their production and they will deal with their deliveries and I think theres a lot of challenges here. So as it relates to what they produce and what's their new production what are they deliver out of stored aircrafts thats really kind of something Boeing has to address we know what our obligations are and what our requirements and we are.
Trying to give you as pets best colors, we can over the what we see over the next seven to eight months.
Got it and now that Youre above 31 should we expect excess costs to be de minimis.
How much of the excess cost of specifically of the $3 7 million as everything above 31, no longer excess.
No. We will still continue to see that I think in 2020, we incurred about $280 million as exit costs. In 2021. It was around $2 10 to 220 I would expect it to be.
40% to 50% lower here in 2022 because of that rate increase.
Yes, Mark the excess costs will continue till we get back to a 52 right right yes.
It will go down again, we'll still have some excess cost in 2023.
But we're expecting it if we go up in rate it'll go down again in 2003.
Got it okay. Thank you.
Thank you.
Thank you so much for your question. Our next question comes from Cai von <unk> from Cowen. Please go ahead.
Yes. Thanks, so much so you gave us.
<unk> planned for the year for those two Boeing programs, what about 2020, and the <unk> hundred 50, because you seem to be going pretty hot.
The <unk> hundred 20 in the first quarter.
Yes, well on the <unk> hundred 20 Cai.
As you saw from our results we delivered 155. So we're right now we're probably at about 55 and where.
We're planning to go to the 65.
The middle of 2023, but if you just look at a total number.
<unk> just over 600 on the <unk> hundred 20 and on the <unk> hundred 50 were expecting about 50 units. So it will be average a little bit over four between four and five for the year.
Very helpful. And then Mark you mentioned prepay the UK loyalty.
291 million I assume that's happening below the line because the Boeing advances are above the line.
And what is the interest rate savings the interest.
<unk> savings youre going to have on that retirement.
You are correct Cai it's.
The majority of the $291 million the majority of it will end up.
Flowing through our free cash flow statement in the financing section.
It's a debt like liability right.
And we talked about this before on the fall last year, we increased our term loan by about $200 million.
At a base interest rate about 375, and I think we had told you guys that we were paying.
When Bombardier did this deal it was cut at a 7% to 8% interest rate so.
Effectively we used $200 million of the term loan of 100 million of cash off our balance sheet with the cash balance we have and we're going from the $200 million from 8% to under to under 4% and we expect to see roughly a little more than a 20 $20 million benefit.
Cash interest expense on a go forward basis.
And the last one is.
When you look at.
Where you are likely to be in terms of 737 in the second quarter I mean, if I look at.
My model it looks like pretty much all of the Q to Q increase first quarter, the second quarter in revenues.
Is the 737, so should we assume you got a big margin step up in the second quarter or do you still have gate up costs from go into 31, so that it's not going to be as big how should we think about that step up.
Well as I said, we're now at 30 delivering at 31 here in the month the month of May. So if you think about it April was still at 21 months.
May and June will be at at 31 months. So we're not going to see the full incremental benefit of producing at 31, a month in the second quarter.
Think you'll you'll see.
Still a little bit of trailing cost as it relates to breaking to that rate that we incurred in the month of April .
So youre going to see a nice pick up in revenue youre going to see a tick up in earnings and cash.
Cash flow follows after that I think.
Really you would want to measure us on when we get to the third quarter at that point in time, we will be fully delivering full up at 31 aircraft per month, we will we will get the peak revenue in that quarter, and Im really expecting revenue and earnings to be meaningfully improved.
And we will start to really see the benefits of those production rates flow through cash flow.
Terrific. Thank you.
Thank you for your question.
Our next question comes from Ronald Epstein from Bank of America. Please go ahead.
Yes.
Good morning, guys.
It seems like 700 has been sort of breaking it up there so maybe changed to change topics a little bit.
So Tom with.
What's going on in defense markets today.
Do you expect kind of more more flow through your defense business than you were previously anticipating maybe six to nine months ago.
Well Theres certainly been a pickup in activity in the defense budget has gone up to reflect some of the new requirements for what's going on in Ukraine, but just more broadly.
What we have seen is a lot of activity in terms of bids and proposals.
As we mentioned.
Earlier back in 2016, we only had four programs that were over a $1 million and now we have over 30 such programs. So.
That's what's happening and as I've said before we have a lot of capacity that used to be for wide body for composite fabrication. So things like automated fiber placement machines autoclave, driven drill non destructive inspecting.
That kind of heavy capital equipment that we were able to repurpose to defense and we're able to offer that immediately to the defense primes and Thats helped us win some new programs.
So we do expect as I mentioned in my comments, we have a very solid pipeline. We've won some programs and those are classified programs that are in the development phase, but as those get through development phase and into production that should drive continued defense growth. So we're very optimistic about the defense opportunity in the key areas that we're focusing on so of course.
Next generation aircraft, but also missiles and hypersonic and we have a very strong capability in hypersonic <unk> with our new F&I group out in Maine, which makes the <unk> carbon carbon that's used on high temperature surfaces.
And then we're also looking at things like attributable drones, which should be a big part of the force of the future and then space. All of these areas are heavily focused on structures and thats really where our expertise. So we're very bullish on the defense and space market outlook.
Gotcha Gotcha Gotcha, and then maybe changing gears to business aviation and what you've got going on in the.
In Belfast.
What's going on in that end market.
As bell faster and better than you would have anticipated.
The demand for large cabin business jet.
Let me ask Sam to address business jet she oversees that.
Sure.
Excuse me thanks, Tom.
So we're seeing a lot of from the growth side of things, we're seeing a lot of.
Opportunities coming up for us to look at and to bid on so that side of the business is staying pretty much pretty pretty stable in terms of.
Get some production what I would say is that.
Opportunity pipeline has certainly increased and second kind of related to that market, we talked a little bit about the vitol emerging market, particularly on the technical consulting side of things the engineering services.
Side of the business.
Suddenly start to pick up as well so what I would say at this point is it is kind of holding its own on the business jet side of it there's a lot of opportunities that we're chasing and we do have a couple of new business jet programs, yet to be announced yet right. Yeah, well one was one with the Falcon tax yeah.
Gotcha Gotcha, alright, great. Thank you.
Welcome.
Thank you. Our next question comes from Noah <unk> from Goldman Sachs. Please go ahead.
Alright, good luck.
Hey, Noah.
Morning.
Good morning.
On the Max Boeing.
Boeing given you the next rate rig it's timing.
And then reverse that on you.
Or were you.
Making your best assumption and having to manage your business.
It's more of the latter no as we've said we are always working on rate scenarios and and those change based on circumstances. So.
The schedules that we currently have right now with Boeing is we're going to stay at 31 for the rest of the year.
Previously we had expected a rate increase in the fourth quarter, but we don't expect that right now.
And so we're again, we're always working on different scenarios, but we have to be agile. This is a very challenging time right now very dynamic and so we're going to be flexible.
Yes, no what I would just say, we get kind of a skyline update from call at Boeing and Airbus routinely.
And with all the challenges in the marketplace as it relates to Covid and now Russia Ukraine.
We're seeing more more skyline adjustments than we've ever seen before and so you get a skyline, which kind of gives you an indication of where you think things are going right, but at the end of the day, it's got to be the formal purchase order right that comes through.
I think we.
We're coming on the back end of Covid, we're seeing a lot of recovery on the.
On the airline side of things and seeing more stability, but theres still a lot of uncertainty right. I mean, Boeing is delivering out of their storage they've got the issue on the 77%. So I think we still have some uncertainty I think it's clear.
On the Airbus side, where they want to go.
But those skylines adjust and change and then we have to adapt to the purchase commitments that are flow down to us and we wanted to give you clarity in terms of what we see now for the rest of this year now that we're into May and on the Max That's why we said right now our plan is 315 units.
Yeah, Okay that all makes a lot of sense and it's helpful.
There's a lot of focus on China, when China will resume deliveries on the Max.
It almost seems like to your point Mark there's their size as a percentage of the total Max backlog, but then there's also just the issue of there in the skyline. So even if there are enough aggregate customers to have a certain production rate.
There's so much skyline movement that has to happen that you can't take it to a higher rate.
Is that a fair take that but thats almost a bigger challenge in the near term then.
The size of the customer.
I don't know I don't have that deep knowledge of how Boeing manages their their skyline and how they move slots and how they work with the airline customers.
That's more of a question for them.
<unk> not worked out.
At an OEM, so I'm not quite sure how they manage it but but obviously if there.
There's a lot going on right now and I think we're trying to do the best we can to support our customer 307 as important to US $3. Seven is really important to Boeing and we're trying to stay lockstep and make sure that we deliver on time and support their support them as they deliver to airline customers.
Sure.
I could see the answer here also being it's a better question for Ralph.
Good to get.
Mosaic of opinions and it's a big part of your business does anyone anywhere in the system have any visibility on.
Why and when China resumes deliveries over the next.
I would say.
From our standpoint, we do not.
We depend on what we hear from our customers Boeing and Airbus and also what we what we read but it's obviously a very complex situation with a lot of different dynamics and so we don't have any clarity on that now.
Okay.
Alright, thanks, so much for taking my questions.
Thanks.
Thank you.
Our last question comes from Michael <unk> from curious Securities. Please go ahead.
Hey, good morning, guys. Thanks for sticking around for taking my question.
Just I guess, mark just on the excess capacity costs.
Specifically drove the 5 million sequential increase from the fourth quarter and I guess now with.
The Max at 31 for the full year and the 787, where it is I mean looking into 'twenty three I mean, if youre going to cut excess costs by call. It 50% I mean, it still seems like theres going to be a pretty big drag.
Into 'twenty three given your lead times on brakes, I mean should we kind of just calibrate ourselves for some residual excess cost in the $40 million to $50 million range in kind of 'twenty three.
Yeah.
Yes, I mean, if you if.
What I said it was around $2 10 $2 20.
In 'twenty one.
We're breaking through to 31, and that's going to help reduce that to call. It cut in half to 110 120.
With that pegged our rate of 52 aircraft per month.
If we go back up in rate Youll see another tick down the higher we go up the bigger benefit we see from an excess standpoint, and so you really didn't see a big drop.
First quarter compared to fourth quarter, because we werent delivering at 31, a month, you'll see that a nice tick down in excess costs in the second quarter as we start to deliver at the higher rate, yes, but I would say the reason it went up $5 million very simple there are some costs during the first quarter to get ready for the rate increase so that contributed to it and also there was a <unk>.
<unk> adjustment on the emcee 'twenty, one that I mentioned and so those are the two factors that drove it from what was 45 million in Q4 to basically $50 million in Q and Q1.
Got it got it even still.
Max goes up to $42 47, and if I look at your narrow bodies getting to rate I mean, it seems like the wide bodies are still going to be under pressure. So that's going to be some residual cost excess cost regardless, you can actually get back to 5% and $83 56 in triple seven where it is it still seems like youre going to have that wide body drag.
Yeah.
Well Michael.
There are specific accounting rules around how we treat excess costs.
But the widebody lower production rates.
Those costs today, there is not a separate excess cost calculation for the twin aisles. Those are embedded in the profit rates that we have today, but lower production on our twin aisle programs.
Asleep puts pressure on our twin our margins.
In some instances on a large site like Wichita can have negative impact across the board. So there is definitely a headwind.
As it relates to those lower production rates.
Got it thanks, a lot guys.
Okay. Thank you.
Thank you Michael for your question at this time there are no further questions.
Our conference call has now concluded I would like to thank everybody for joining today's call. You may now disconnect your lines.
Okay.
Yeah.