Q2 2022 Spirit AeroSystems Holdings Inc Earnings Call
Many of our customers suppliers and other stakeholders.
At the Air show, we saw continued narrow body demand improvement with Boeing securing multiple 737, Max orders, including 100 737, Max Dash tens from Delta Airlines prior to the show in early July Airbus also secured a large narrow body order for nearly 300 <unk> hundred twenty's.
Those orders reinforce the improved long term outlook for narrow body aircraft that support future production rate increases.
While the long term outlook remains favorable this quarter, we did experience economic pressures like the rest of the industry.
As we ramp 737, Max production to 31 airplanes per month in May we saw additional challenges surface and our supply chain.
These challenges at some suppliers resulted in part shortages in our factories as a result, we are taking longer to stabilize at rate 31 aircraft per month on the Max and have taken the opportunity to burn down the few slides buffer we have in Wichita, which was reduced by 19 chipsets during the quarter and now sits at 66.
Chipsets overall, we now expect to deliver about 300 737 Max units in 2022.
We also saw a number of scheduled changes this past quarter, particularly on the <unk> hundred 50, 767 and 787 programs.
These schedule changes contributed to the forward loss this quarter.
The 787 program also required some additional engineering analysis to support Boeing's efforts to resume deliveries we continue to respond to all of <unk> questions on the 787. So they can complete their work with the FAA.
In addition, we saw several supplier bankruptcies that created challenges this quarter on the <unk> hundred 20 program. One supplier bankruptcy drove a forward loss of $25 million related to scheduled recovery efforts and transfer of work.
Through the efforts of our supply chain team, we have been able to ensure supply continuity to our customer.
Also we are experiencing challenges with inflation on purchase services logistics and transportation that have created some headwinds to our results.
Finally in light of the Russian invasion of Ukraine, or customer stopped shipping parts for an aircraft program due to the uncertainty of that program. We have taken a net charge of $28 million related to adjustments of certain assets and liabilities associated with U S sanctions on Russia.
Our defense segment continues to show solid growth.
Recently, we had three big wins in defense.
<unk> was selected to provide the pylons into cells for the B 52 Reengine program.
Second tier space also awarded spirit, the shooting star cargo module for their Dream Chaser program.
Third in mid July we joined Airbus helicopters as a strategic partner to support the British produced 875 am for the Uk's new medium helicopter requirement.
These wins demonstrate the momentum of our defense business in its core markets, our defense and space growth strategy is moving us into new markets and expanding our relationship with the Oems and primes.
The aftermarket business also had a very good second quarter growing revenue by 42% over the second quarter of last year, and delivering 15% margins without losses on Russia related programs margins would've been about 20%.
We also expect to see the business and aftermarket benefit from new opportunities like the recently announced deal with Boeing Global services on the Max and the <unk> partnership in China.
I also want to highlight that.
We released our second annual sustainability report in July we said, our progress toward our sustainability targets, including key accomplishments of transitioning to 100% wind power at both our Wichita and Tulsa facilities.
In addition, we completed an agreement to install a large solar panel array on the roof of our Malaysia facility, we continue to leverage our research and technology investments to assist in the development of newer more fuel efficient aircraft I'll now turn the call over to Mark to take you through a few more details on the financials of our second quarter results.
Mark.
Thank you Tom and good morning, everyone.
We feel optimistic about the strength of the post pandemic aerospace recovery as we continue to see narrow body production rates increase.
That said, we experienced some near term pressures this quarter.
We received scheduled changes from our customers and face constrained supply chain labor shortages and rising costs.
These challenges are not unique to spirit and I am confident in our ability to manage through the uncertainties over time.
Now, let me take you through our second quarter financial results.
Let's start with revenue on slide three.
Revenue for the quarter was $1 3 billion up 26% from the same quarter of last year.
This improvement was primarily due to higher production on the 737 and increased aftermarket revenue, partially offset by lower production on the 787 program.
Turning to deliveries the narrow body programs in the second quarter of 2022 were 60% higher compared to 2021.
With 234 deliveries in the second quarter of 2002 compared to 146 in the same quarter last year.
The 737 and <unk> hundred 20 programs each had increased deliveries.
The second quarter 737, Max deliveries were 71 units compared to 35% in the second quarter of last year, while we delivered 147 <unk> hundred 20 <unk>.
Compared to <unk> 96 in the prior year.
Wide body program deliveries were down 19% to 35 units compared to 43 in the second quarter of 2021, driven mainly by the 787 program.
Overall deliveries increased to 318 units.
Compared to 235 in the same period of last year.
Now, let's turn to earnings per share on slide four.
We've got a lot going on from an EPS standpoint, this quarter. So I plan on walking you through the key drivers that impacted earnings.
We reported earnings per share of negative $1 17.
Impaired to negative $1 30 per share in the second quarter of 2021.
Adjusted EPS was negative $1 21 <unk>.
Compared to negative <unk> 31 in the same period last year.
2022, adjusted EPS excludes the deferred tax asset valuation allowance.
Gain related to the settlement of the repayable investment agreement and losses related to the <unk>.
Sanctions.
While 2021, adjusted EPS excludes restructuring costs and the deferred tax asset valuation allowance.
We continue to see supply chain challenges with many of our suppliers experiencing staffing pressures, resulting from a tight labor market and less experienced new employees as they have increased production rates in turn this has led to parts shortages and disruptions in our factories during the quarter.
We also experienced further increased inflationary pressures and logistics energy consumables and other indirect areas.
Operating margin was negative 8% compared to 10% in the second quarter 2021.
The margin increase reflects increased production rates, partially offset by higher unfavorable changes in estimates and losses related to Russian sanctions.
Operating margins in the quarter were negatively impacted by significant events, including supplier bankruptcies.
Losses related Russian sanctions and production rate changes.
This quarter's net forward losses were $64 million.
And we had unfavorable cumulative catch up adjustments of $8 million.
This compared to $52 million of forward losses, and $10 million of favorable cumulative catch up adjustments in the second quarter of 2021.
The current quarter for losses were primarily driven by the 787 and <unk> hundred 20 programs the.
The 787 charge.
Result of production rate decreases and increased supply chain and engineering costs, while the <unk> hundred 20 charges were the result of increased work increased costs associated with the supplier bankruptcy and cost to relocate that work.
The unfavorable cumulative catch up adjustments during the quarter were driven by scheduled changes parts shortages and increased estimates for supply chain freight and other costs, mainly on the 737% and <unk> hundred 20 programs.
In relation to the sanctioned Russian business activities, we recorded losses of $42 million and the reversal of a previously booked forward loss of $14 million for a net charge of 28 million. These charges resulted from impairments on inventory and capital as well as reserve adjustments.
Second quarter 2022 earnings also included $45 million of excess capacity costs.
The decrease of $3 million over the same period of 2021.
The quarter did not include any restructuring or abnormal COVID-19 costs compared to $8 million of these combined expenses during the second quarter of 2021.
Other income for the second quarter of 'twenty two.
<unk> was $35 million 4 million higher than the same period last year and reflects several offsetting items, including a gain of $21 million related to the settlement of the repayable investment agreement and.
And higher foreign currency gains.
Partially offset by lower pension income higher excise taxes and losses on foreign currency forward contracts.
Now turning to free cash flow on slide five.
Free cash flow usage for the quarter was $62 million.
Cash usage was higher this quarter compared to the same period of 2021, driven by higher working capital due to increased production activities.
Quarterly cash repayment of $31 million related to the Boeing 737 advance received in 2019.
In the interest associated with the settlement of the Repayable investment agreement. Additionally.
Additionally, during the second quarter of this year spirit received the remaining $25 million of the AAM JP program Grant Award.
Which was awarded in 2021 and $27 million of pension related cash benefits net of excise tax.
Looking ahead.
Due to lower 737 deliveries than previously expected ongoing supply chain disruptions and continued inflationary pressures. We are now targeting full year 2022 free cash flow usage between $250 million to $300 million inclusive of the $123 million Boeing advanced.
Repayment.
This reflects estimated capital expenditures of $125 million to $150 million.
Higher 737 deliveries, our effective management of working capital and burn down of inventory are important to achieving this year's free cash flow improvement in the back half of the year.
In addition.
Further inflation schedule changes and supplier disruptions could have an adverse impact on full year cash flow expectations.
With that let's now turn to our cash and debt balances on slide six.
We ended the quarter with a healthy cash balance of $770 million and $3 $8 billion of debt.
The cash balance reflects the payment of 293 million made during the quarter to the Uk's Department of business energy and industrial strategy to settle the repayable investment agreement, which we acquired as part of the Bombardier acquisition in 2020.
We remain committed to reducing debt levels through cash flow generation as narrow body production rates improve over time.
Now, let's discuss our segment performance.
First beginning with commercial on slide seven.
In the second quarter of 2022 commercial revenue increased 28% compared to 2021.
Primarily due to higher production volumes on the 737 Triple seven and <unk> hundred 20 programs, partially offset by lower production on 787 and 747 programs.
Operating margin for the quarter.
Improved to negative 4% compared to negative 6% in the same quarter of 2021.
The slight improvement was due to higher volumes on the 737 and lower costs related to excess capacity and restructuring partially offset by higher changes in estimates and losses related to the Russian sanctions.
The segment had combined excess capacity and restructuring costs of $43 million compared to $50 million in the same period last year net <unk> losses were $59 million, an unfavorable cumulative catch up adjustments were $8 million during the second quarter of 2022.
In comparison during.
During the same period of 2021, the segment recorded $51 million of forward losses, and $11 million of favorable cumulative catch up adjustments.
In relation to the sanctioned Russian business activities. This segment recorded losses of $38 million as well as the reversal of a previously booked forward loss reserve of $14 million.
Next let's turn to defense and space.
On slide eight.
Defence and space revenue improved 3% compared to the second quarter of 2021 due to increased production and development program activity.
Hence in space revenues did see some pressure in the quarter from changes in timing as well as the shift between development and production on classified programs.
Operating margin for the quarter was flat compared to the same quarter of 2021.
The segment recorded excess capacity costs of $2 million and forward losses of $4 million compared to excess capacity cost of $2 million and forward losses of $1 million in the second quarter of 2021.
For our aftermarket segment results, let's now turn to slide nine.
Aftermarket revenues were up 42% compared to the same period of 2021, primarily due to higher spare parts sales as well as higher maintenance repair and overall activity.
Operating margin for the quarter decreased to 15% compared to 26% in 2021 due to losses of $4 million related to the sanctioned Russian business activities.
In closing, we're feeling the impacts of the strained supply chain, a tight labor market and increased costs and the associated impacts of these pressures to our customer production rates.
While our recovery depends on some factors beyond our control.
We remain focused on execution and delivering on our commitments to our customers now.
Now, let me turn it back over to Tom for some closing comments.
Thanks, Mark the long term outlook for the global Aerospace industry continues to remain strong and supports increased narrow body production rates. We believe spirit is well positioned to benefit from the recovery of domestic air traffic and the increasing narrow body production rates since 85% of our backlog is narrow body aircrafts.
Our current focus is on managing challenges in the supply chain and near term pressures caused by inflation and other global events.
As we see our 737 Max production rates stabilize we expect to see steady improvements over the remainder of this year.
Our diversification efforts are progressing well with the defence and space to securing additional work statement in this quarter. We also have a healthy pipeline of emerging opportunities that the team continues to pursue that could provide additional future revenue.
The aftermarket team has diligently worked to build a strong foundation and we expect the segment's revenue growth to continue as aircraft utilization recovers with that we'll be happy to take your questions.
Certainly.
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The first question is from the line of Doug Harned with Bernstein. Your line is now open.
Yes, thanks, good morning.
Good morning, Doug.
You talked about.
The 787.
My understanding was that.
And the work with the FAA there was one outstanding issue that related to section 41, but my understanding was that the <unk>.
<unk> of that was pretty much in hand now.
Can you comment on where that stands and what work needs to be done because I'm thinking about this both in terms of.
Getting delivery restart, but also what the impact would be or a new of the timing.
Getting the 7% seven production backdrop.
Right well a couple of things.
<unk> worked closely with Boeing on responding to all of their questions related to the work statement. We have on the 787 and we've submitted all of the engineering analysis that they've requested now there was some additional engineering analysis this quarter, which Mark mentioned that was part of our forward loss, but all of that work is complete.
I have ever requested and we have submitted it.
And so we're working with them closely so that they can complete any outstanding items with the FAA and resumed deliveries now we did see the press reports last week that there were some encouraging signs on that.
So we'll continue to support Boeing but as far as we're aware there is no outstanding engineering analysis that they need from us.
For our work packages on 77.
And then if I can just.
One more one more thing this quarter, we were surprised by the UK cash payment. We didn't didn't know about that can you just help us understand if there are any other.
Other puts and takes we should be looking for in the next two quarters with respect to cash and other one offs either positive or negative.
While the UK item is something we actually mentioned last quarter as.
Subsequent event.
So we did try to give everybody a heads up that it was coming and as we described it it was really to pay off some liabilities.
And just clean up the balance sheet to reduce future interest expense.
Over the next couple of quarters really.
From a cash standpoint, the items that are still out there that we've mentioned before is the repayment.
That Boeing advance that we got in 2019 was $123 million. So its about $31 million a quarter that were paying off so in the next two quarters, we have about $62 million of that left to pay.
So that's what's kind of the outlook for cash in terms of one offs.
I just wanted to go back because you did ask about production rates and we're at the same rate Boeing is at which is about two aircraft per month, we expect to deliver roughly 20 units. This year. We've delivered seven so we've got about 13 or 14 more to go for the year.
Okay, great. Thank you.
Thanks.
Thank you for your question. The next question is from the line of <unk> <unk> with Jpmorgan. Your line is now open.
Hey, thanks, very much and good morning.
I was wondering given the new starting point for cash.
Flow.
In 2022.
How we should think about the possibility to generate cash in 2023 and what the big building blocks are and then Mark I guess if we.
If the company is to end the year with let's say $850 million of cash on the balance sheet and.
First half is often a use of cash I think there is $300 million of debt coming due.
By the end of the first half of 'twenty three.
How do we think about your approach to <unk>.
All of that.
Well, let me, let me answer the back half of the question and Tom can chime in on the on the first part.
When you think about the adjustment to our cash flow this year.
Some of that is just really working capital timing right, we're going to deliver less units.
With some of the supply chain challenges, we're going to have to build up some more strategic buffer from an inventory standpoint, so some of it isn't.
<unk> loss cash, it's going to be made up over time.
So I just wanted to make sure that you understood that but secondly, as it relates to your comment about the debt requirements next year, and having roughly $850 million of cash at the end of the year and you are right first quarter is from a seasonality standpoint is always our toughest quarter from a free cash flow standpoint.
We expect that we will use cash off our balance sheet.
To pay down that debt.
At this point in time, we don't believe that there's any need for us to refinance it and we expect to pay down that debt via the cash on our books.
Expected cash flow.
That should come with higher production rates as we move forward into 2023.
And Seth.
On the building blocks for next year, obviously, the most important our production rates, particularly for the 737 Max.
Since we're at 31 now we expect that we would be at at least 31 aircraft per month for the whole of 2023 and as we said in the high <unk> low <unk> in terms of Max production rates spirit is at breakeven.
And so so that is obviously going to be a key building block. The other thing we expect is 787 deliveries.
Tim.
Our recover some more which will help bring down some working capital that we have in terms of with.
Then.
Third working building block would be our continued focus on working capital and streamlining our inventory as those production rates go up and then of course very prudent capital expenditure management. So those would be the major building blocks for next year and we do expect given the current outlook that we would be cash flow positive next year in 2023.
<unk>.
Okay, great. Thanks, Thanks very much.
Thanks, Jeff.
Thank you for your question. The next question is from the line of Rob Spingarn with Melius. Your line is now open.
Hi, good morning.
At a recent conference you had mentioned that she is exhausted your recall list incremental labor would need to come from external hires. So I wanted to ask you to talk about that process, how thats gone and.
Because I think earlier one of you mentioned that your suppliers, having trouble with later, but I want to see how youre doing with that and then how's the learning curve on getting the newer people up to speed and does it affect the relationship between a 42 rate on the Max in the 16, 5% Mark.
Yes.
Right so.
You are right, we have more or less exhausted our recall list and so we have started to tap into the market for new employees, but we did have a job. There last month, we had over 200 people. We extended almost 700 offers so we are seeing.
Good take up in terms of employment in the Wichita area.
In Tulsa for example were actually slightly over our staffing number right now so very solid there and same in kinston and our overseas areas.
<unk>, Belfast, Morocco, Malaysia, Saint Nazaire, and France are all basically at their staffing numbers. So I would say our current staffing is solid we do have to hire a few more people in Wichita, but one thing we've been able to do is shift around resources from some of the other programs. So for example, 787 production rates are down.
We have shifted a lot of 787 staff to the 737 program.
So I'd say, we're fairly stable and the fact that production rates are going to remain at 31 per month for the rest of the year gives us time to absorb that and to do the training that we need the learning curve on new employees. We generally look at we need about 90 days to get staff hired get them through the basic training get them through their specific.
Training and then get them on the job training. So it's those kind of three phases and we try to lead 90 days to do that and just being on the floor yesterday at our in our training center.
We've got a lot of retirees that we've brought back for example, and they are helping with that training and so it's I would say its basically on track to what we what we normally expect.
So you still have the same margin target.
At rate 42.
Yes, yes, yes.
Obviously there'll be challenges, but once we get to a 42% and that's obviously been pushed a little bit to the right, but once we stabilize there.
Our target of 16, 5% in all of our plans are built around that absolutely.
Great. Thanks.
Thank you for your question. The next question is from the line of Cai.
The bond remora with Cowen.
Your line is now open.
Okay.
Yes, Tom So I was surprised that.
You said you had 66 units stored at the end of the quarter.
I assume that's down about 30 during the quarter, which would've said you were nowhere near close to 31 per month in terms of a run rate maybe explain to US why and then going forward. When you talk of 31 per month, I mean, Boeing talks of 31 per <unk>.
But theyre not there because they have to pause the rate to avoid traveled work. So what is the effective actually produced number in that 31 and what is your Boeing scheduled deliveries for the rest for this year for the total of the 737.
Right. Okay. So let me explain the buffer I believe at the last call. We mentioned that we were at 85. So we're now at 66, so that's a reduction of 19.
To be clear. These are Boeing owned buffer units that are stored in Wichita. These are fuselages and I want to also be clear that it's not all a result of us lagging Boeing some of it as I've said in the past as we plan to have a buffer of about 20 units, which will maintain its a permanent buffer to cushion the production system.
And in fact, we've already started to reposition some of those buffer units from Wichita up to the Seattle area. So that they are closer to the rent and site, that's where there'll be stored for the long term. So that process has already begun and thats why the number dropped as.
As much as it did this quarter. It wasn't just to as a result of lagging Boeing in terms of production rate for the year. After the remainder of the year. We are at 31, we did drop a little bit to allow the supply chain to catch up in June may and June , but we are back to 31 and the effective rate that we're producing is 30.
One.
So that's the number that will be coming off of our line.
We expect this year is that we will produce about 300 Max units. So last quarter, we said $3 15.
Taken some out of the schedule this year to allow the supply chain to recover and burn down some of that buffer inventory. So we're now expecting 300 total units for the year and I believe for the year.
We have already delivered about 131.
So we've got.
170 units or so to go.
But so if you have 66.
Your premises, but some of them have been shipped to Boeing Boeing has more excess fuselages right. Because they are basically have not been hitting their 31 per month rate. So that really buffer in terms of the destock you have to go through it's a little bit bigger is that the right way to think of it.
It's not bigger than it was in Q2, but.
I'd say the property is I would say basically flat to where it was because we've been more or less at the same rate as Boeing and the goal, though is to position about 20 units permanently up in the Seattle area to cushion the production system and then to burn down the rest of what's in Wichita.
So I'm just trying to give you some transparency of whats left in Wichita and whats Youre in Wichita is about 66 units.
Got it thank you.
Okay.
Welcome.
Yes.
Thank you for your question. The next question is from the line of Sheila.
Glue with Jefferies. Your line is now open.
Hi, Good morning, guys. Thank you for your time.
I wanted to walk through.
Cash in the first half a little bit and why and how that translates into what happens happen eventually.
<unk>.
<unk>.
When we think about.
Cash flow outflow of $375 million in the first half.
If we neutralize working capital we're talking about pop anyway, that's 209 going away and then take away $100 million of one time items that you guys had in the quarter, we still get to that $60 million.
Cash flow outflow.
So I guess with what changes on what gets better.
As maybe the Max does that burn rate, but you didn't mention inefficiencies there.
78.
Okay.
What I'm going to walk through that.
Right well sure I'll give you a high level overview, and then mark will jump into the details, but I would say for the second half of the year.
There are five levers that will help cash. So the first is 787 rates will be at 31 per month for the entire six months of the back half and so that is going to be a big driver of cash in the second half. The second is what I mentioned earlier is the 787 deliveries.
We only delivered seven in the first half, but we're planning to deliver 20 for the year. So we still have 13 to go so pretty much doubles, the production or the deliveries of 787 in the back half.
The next driver main driver is working capital burn down.
We do have a lot of inventory.
And as the production rates go up it will give us the opportunity to burn that inventory off.
We will also continue to manage capital expenditures very prudently and some of the supplier bankruptcies have created losses for us and we do have supplier recoveries that we can target and we'll be working on that in the second half. So those are the five building blocks for what will drive cash performance in the second half.
Mark maybe you can add some additional to that.
I think you captured it well Tom but.
As Tom indicated.
We're going to deliver 170 730 sevens in the back half of the year.
And that helps from a cash flow multiple ways. One is it's our it's our most profitable program.
And so that will help improve.
Profit and cash to the bottom line, but also as we stabilized at 31, a month, we were going up in rate in the first half of the year. We brought on a lot of inventory. If you look at our inventory, it's pretty much flat in the first half of the year. So as we stabilize the 737 production rate will be able to burn some of that inventory that we have.
Built up and create a buffer to protect protected production system.
Three seven will be cash flow higher cash flow generation in the back half of the year, we won't be stocking up the inventory, we won't be building blip to get the production line.
Ready for the higher delivery rates, and we're going to see stable deliveries in the back half of the year as Tom said, we'll see some modest improvements from a working capital by doubling our 787 deliveries.
We've got a lot of Wil with built up due to the fact that there hasnt been any deliveries in more than a year that will help out.
And then I expect us to do a much better job of burning down inventory in the back half of the year. If you look at our.
What we did from an inventory standpoint in 2021, we were close to an improvement of over 100 $100 million and so we expect to pick up the pace of getting our inventories in line with production rates in the back half of the year. So I think those are some big big drivers to it.
There is there is a lot of.
A lot of challenges in the marketplace, but based on those factors.
And where we see ourselves going between now and the ended the year with really driving production stability.
Stability and not needing to add strategic buffers because of some supplier challenges in the first half of the year.
We think we're in a position we expect to go get there, but it's going to take a lot of hard work.
Can I just follow up on the 77, because I thought that was a cash generator for you guys given the advances of 400 per ship that and.
Maybe up 10%.
Yes.
So I thought you were losing $1 million per unit, how does how's that.
Cash accretive.
So so really yes, so sheila the way that works is you are right those comments are exactly right but.
But we started the year.
Work in process.
A significant number of units right that we were coming off of production rate that went from 14 to 12 to 10 down to five.
And so the number of units at the beginning of the year that's in the production system.
A lot of them almost completely built the number of units that will be in the production system will be dramatically lower at the end of this year compared to end of 'twenty, one because the production rates are so much lower.
Although we lose money on that will be carrying.
At an absolute basis less whip units in the production system at the end of this year than we had last year and that creates some working capital benefit.
Okay. Thank you so much.
Thanks Sheila.
Thank you for your question. The next question is from the line of Christine We work with Morgan Stanley . Your line is now open.
Hey, good morning, guys.
Good morning.
Hey, Kristine how are you.
In terms of cash.
If you look at your net debt ticked up from $2 6 billion last quarter to $3 billion at the end of this quarter and with the lower free cash flow outlook for the full year 2000 to any cash balance cash still gets under pressure can you discuss your debt covenants that you have.
Monitoring.
And actions you could take avoid potentially breaching terms.
Yes, so Christine when you look at our capital structure today.
We don't have any traditional banking relationships not a revolver.
So when you look at our or the debt that we have on our books today, it's a combination of of bonds right in the capital market debt holders as well as term loan b, which is with with.
Debtholders public debt holders.
So based on on.
The structure of those debt arrangements there are no what I would say no.
Quantitative.
<unk> requirements.
From a call it a cash balance standpoint or from a leverage standpoint, so no real challenges as it relates to any type of potential covenant issues.
Debt agreements.
So.
That is not anything that we have to worry about from a near term perspective, we obviously want to.
Very focused on cash and maintaining an appropriate level of cash balance and also very focused on paying down debt.
As we returned to cash flow positive so no near term challenges as it relates to covenants, we talked a little bit about kind of the plans on how we will deal with our bonds that come due in the middle of 2023, but I think we're okay here in the near term.
That's really helpful color and if I could do a follow on in defense.
You took a $2 million forward loss last quarter $4 million. This quarter are these forward losses on related to the same program.
And if so can you provide some context around the size of the contract and potential risks going forward.
Yes, sure Kristine, it's pretty straightforward about $1 million.
Was associated with with.
With the V 280 program that we're supporting and so we have kind of a <unk>.
Cost sharing arrangement with our customer there until that contract gets awarded so that was a small a small modest four loss due to kind of.
Just a little bit of a delay in the government awarding that contract we've got our fingers crossed that we're going to be on the winning team.
And then.
The tanker or are on the defense side, our tanker on that along with our commercial <unk> 767 share. The same production line and we had a forward loss on the 767 program a lot of that had to do with some some pauses on the commercial production system and so.
That program shares in that cost structure and that resulted in a couple of million dollars charge.
Being allocated the defense, but theres no systemic challenges around our defense programs.
That we see at this point in time.
And I would say that if you look at the defense revenues the growth did look modest at 3%, but overall, we're expecting about a 15% annual increase this year as well.
We get past some of these transition issues in terms of moving from development to production on a couple of the bigger programs.
But we have a lot of confidence in the defense business. We've had these wins it's on track for a very solid year.
And Mark just highlighted some of the issues that were impacting the forward loss, but they.
Relatively small.
That system it systematically.
Great. Thank you for the color.
Thank you for your question. The next question is from the line of David Strauss with Barclays. Your line is now open.
Thank you.
Tom could you maybe just clarify on the on the Max buffer I think we were at 100. Originally we were going to get down to 20. This year. Then I think you had said, we werent going to come down really at all and now we're down 19, I mean, how does that how do we get to 'twenty from 66 today.
Does that progress.
Alright, well.
It really is what we've always said is in order to burn the buffer down we have to lag Boeing in terms of production rates at some point.
So again the reason we originally said it was going to go from 100 to 2000 over the course of this year as we expected Boeing to be going up in rate.
And then we would lag them, but they didn't go up in rate and we're now basically at the same rate of 31, and so we expect it to level out now the reason.
We're down to 66 in Wichita is what I was saying to Cai is that we started to reposition some units to.
The northwest so that they are a permanent buffer for the production system.
Before we used to deliver a unit out of Wichita and there was 14 days to the low point in Renton and Seattle and the train would take six to eight days. So it left very little time, if there was any sort of disruption any sort of.
Delay or or something that could.
Impact production.
We decided with Boeing that we would keep that buffer of 20 units and that's the plan. So we started to reposition the units.
Right now the buffer is not burning down in total because we are at the same rate as Boeing but as they go up in the future. We will continue to lag them to burn this down and I don't have an exact time, yet right now in terms of when that buffer will get down to the 20 units overall.
But it will be at some point when Boeing has increase their rates and will lag that.
Okay I got it now.
You guys mentioned you still think you can get to free cash flow positive for.
And neck next year just wanted to ask you. The consensus for next year. I think is 200 $225 million positive free cash flow is that realistic or are you thinking closer to.
Slightly above breakeven for free cash flow next year.
Yes, I would just say it really depends on what the production rates are particularly for the Max.
That is still a big driver for us and if those rates do go up obviously above 31 for us for Spirit, then that will create better cash flow opportunities but.
A little bit too early to call what the production rates will be on the 320 program. The 707 program of $3 50 program and the Max program. So.
I want to comment on a specific cash flow outlook for next year, but it's just going to be dependent on rate.
And as I said in the high <unk> low <unk> for the Max that's breakeven for spirit. So if the rates are above that that will drive positive cash flow for us next year.
Okay. Thanks very much.
Welcome.
Thank you for your question.
The next question is from the line of George Shapiro with Shapiro Research. Your line is now open.
Yes.
Yes.
Mark I wanted to go back to the cash flow.
Because like you said inventories in contract assets, if I look at them in total are about flat year to date, but your payables have actually gone up by $90 million. So effectively you've got a benefit to working capital this year. So.
You were saying something about 100 million liquidation of inventory I thought what happens to payables in that context as I would think they've gotta go down some from where they were in Q2.
Yes, George I think.
If you look at our balance sheet Youre, absolutely right, we have seen our payable balance go up which is.
Is a benefit on the working capital, but I think if you look at accounts receivable that's up over $120 million. So that's an offset consumer of cash so really I think receivables growth is higher than payable growth.
That neutralize each other as you said, we haven't seen from an inventory of contract assets. It's flat so it hasnt generated or hurt us year to date.
In the environment that we're in when we're going up in rate, we should start to burn down the inventory and Turner.
Improve our turns so.
As we as we progress through the year with higher production rates that should result in payable balances staying where it is or slightly going higher with higher production rates, we should see.
AAR tick up a bit but as we drive this stability and we dealt with some of the supply chain challenges, where we had add strategic inventory buffer in the first half of the year, we had to bring in extra inventory because of titanium and the Russian sanctions.
We move into the back half of the year, we should the contract assets, which was building with an aligned to support the 31, a month 737, all of that stabilizes and once we get stable and we get a steady drumbeat.
Drumbeat in the factory will be able to liquidate some of the higher inventories that we have.
We will be able to align our our min Max is better with the current production rates and so in the back half of the year as I think.
Kind of offset themselves and I think.
<unk>.
If we do a good job of managing inventory, we can drive the stability in the production system will see inventories come down in the back half of the year, we won't have to replenish the inventories and that will help improve the cash flow.
Okay, and then if you could discuss your excess capacity costs with somewhat higher this quarter. I think you had been saying they'd be down 40% to 50% for the year is that still the thinking or an Alex Moore.
<unk> plus.
No I think.
It's going to be down around 30% to 40% I think last quarter I told you about 40%, it's probably a tick down from there a lot of that has to do with we as Tom said, we slightly positive factory in July 2737% to give some of our suppliers at time to catch up we slowed down a bit we kept our suppliers.
Hot at 31 months too to make sure that we had the parts at the right time, and so it's a little bit of that slowdown as we moved from the second quarter.
A little bit of impact on the <unk> hundred 20, with some parts shortages on that program.
That kind of stuff bled, a little bit into our excess costs. So I would say, it's not a material change from what we talked about in the first quarter, we still.
We had $218 million of excess costs in 2021, and I still expect it to be 30, or 40% lower so probably somewhere between 140 $150 million this year.
How much more does that come down next year.
I would say that.
We're probably looking at another 40% to 50% reduction year over year, but obviously George it depends on production rates. The excess cost is based on a Max production rate of 52 aircraft per month. So it will disappear when we get back to 52, but.
It just depends on where the rate is in terms of how much we incur next year and potentially into 'twenty 'twenty four and.
31 months helps us reduce the excess inventories or excess costs, and we expect that to happen.
Okay. Thanks, a lot.
Sure thing.
Thank you for your question.
The next question is from the line of Michael <unk> with truth.
It is now open.
Hey, good morning, guys. Thanks for taking the questions just to stay on Georgia line of question there I mean.
Excess capacity costs I mean, if you guys are going to hold 31 months presumably.
If Boeing increases youre going to stay at that 31 to burn down.
The buffer.
I guess, how how far or how long do you envision staying at 31, a month into 'twenty three.
Great do you really need to see Boeing go too.
So you can move up in lockstep.
Given given the buffer that you have.
Alright, well just in terms of the outlook for next year again, Boeing has not really committed to any change from the 31, if you listen to their earnings call.
They said, they're going to wait to see how the overall production system, including engines and systems and electronics, how all that plays out before they commit to what their production rate will be so we'll have to wait to take their lead on that.
But you're right. We're at 31 aircraft per month and the excess costs are really based on returning to 52 aircraft per month. So.
There'll be additional excess costs next year as we remained below 52 now in terms of the lag to Boeing again, we've always said that we will seek to lag them about five per month as they go up until we burn down the excess buffer.
And that will that will vary depending on how fast they go up.
But that's that's basically the equation that we've laid out in the past and that's what we'll stick to to burn down the buffer.
And just Michael for clarity.
If we stay at 31, a month I know how much excess costs will have.
And it will be lower next year than this year, even if we stay at 31 for the full year.
Okay, Okay, but to get a 40% to 50% reduction I mean, even if you go to 42 right. I mean, there is still 20% capacity there so.
This capacity is always going to be lingering to an extent correct.
Yes, it really well.
We will see the lingering impacts of the excess costs until we hit 52 a month.
But as we move into 'twenty, three and we get to 42% and 47 that becomes a fairly small number.
Right.
Not to say it's zero.
But it's a lot more manageable than what we saw in 2021, which was $218 million.
Got it got it okay perfect. Thanks, guys.
Sure thing.
Thank you for your question.
The next question is from the line of Ron Epstein with Bank of America. Your line is now open.
Hey, good morning, guys.
So I wonder Rod of the forward loss was distributed between 787 million and <unk> hundred 20.
Yes, so on the forward loss 87 was around $31 million.
<unk> hundred <unk> was five <unk>.
$25 million and the 802100% of that $25 million was associated with.
Fairly important supplier of ours that filed bankruptcy in the quarter and so we've been onsite presence working with them to recover schedule, which is driving cost to us and then we have a plan to unload that work.
But once you unload it you have to go through first.
First part calls Fai's.
And so it's a sizable impact and so we will see that cash.
B consume between now and the end of the year and into next year. So that's the <unk> hundred 20, and then on 787 about half of that is tied to schedule. Once we got the official schedule. We are seeing we've chewed up to the lower deliveries next year.
A little bit a schedule impact this year.
And then Tom talked about we had some engineering costs to help them support the.
Getting the airplanes delivered to the customers and then we saw some some additional supply chain pressure on 787, we've got a big supplier on the West coast.
<unk> has gone through financial challenges and we're going to move networks from that supplier to another supplier and in the meantime that is going to cause us to have to incur some higher higher.
Prices on the components that we were purchasing from them. So that those two combined are about $66 million of the forward loss.
Got you and then if I kind of go through the program.
And it's in a forward loss of <unk> hundred 50 is in a forward loss.
I think I can infer CAGR and a forward loss and the <unk> hundred 20 isn't for loss and some of this was supposed to fade in 2025 timeframe how has that changed now.
When do you expect for example, <unk> hundred 20, or Belfast to actually have a positive return on the investment.
And when can we expect some of these other programs to actually make a positive return.
Well I would say the <unk> hundred 20 program continues to track very well to our original purchase accounting absent. This one issue on the bankruptcy from the supplier. So in 2025. The rates are supposed to go to 2014 and Thats when the forward loss ends and it becomes a profitable program for us. So that's right on track the integration has gone.
Well, we've transitioned off of the.
The service agreement with Bombardier on information technology.
<unk>.
We ended up closing the pension program, we've renegotiated the Union agreement in.
In addition, we paid off that refundable loan incentive to the UK government. So a lot of very positive things are on track and the flood loss is proceeding exactly on plan absent. This supplier bankruptcy this quarter and we are on track to be profitable.
That program reaches right 14 in 2025.
And then on.
On 787, as we've talked historically.
There is we get a price adjustment at line unit <unk> six we continue to focus on getting the cash flow positive at that line unit and so I think that's about the same timeframe 2025 ish 2026, where we see us getting to.
Breakeven cash flow positive break or positive cash flow and 787%. So those are two big programs that we're really focused on from an execution standpoint.
The delay on the 87% lower production rates and the pause there is kind of put that plan move that plan a little bit to the right but.
Tom talked about the $2 20, what our plans are and I'm just reiterating what we've told.
<unk> told the market on 77.
Gotcha.
Okay. Thank you.
Thanks, Ron.
Thank you for your question. The next question is from the line of Peter Arment with Baird. Your line is now open.
Yes, good morning, Mark Tom.
A lot of questions been asked on production rates, but just bigger picture just given what's going on in the supply chain, maybe you could just.
As Boeing or for this gap.
You have to give like more of an advanced lead time, just if they decided to take rates up so instead of giving the typical say four to six months or whatever it may be when theyre thinking about a higher rate on the Max just given your inside of what Youre seeing in the supply chain and they're going to have to let the supply chain mail earlier. This is obviously thinking longer term. Thanks.
Alright, well there is normal lead time for production rate increase is there any production rate changes is six months roughly.
That's normal obviously, we don't live in normal times right now so we have to be a little bit adaptable and flexible bank does have production rates scenarios that they talk about what the supply chain on a regular basis, and we use that to inform us and to get ready and they.
They use that with other suppliers. So we have various scenarios and we prepare for those.
But the normal lead time of six months, but we've been very flexible in working with Boeing because we know that their environment is extremely dynamic with the airlines and so we've been trying to accommodate that as much as possible but.
But we did have production rate scenarios that go out. The next 18 months and we are working to those so that we're prepared for a variety of different contingencies.
I appreciate that thanks, Tom.
Thanks.
Okay.
Thank you for your question.
There are no additional questions waiting at this time.
That concludes the conference call. Thank you for your participation you may now disconnect your lines.