Q3 2022 Spirit AeroSystems Holdings Inc Earnings Call
Including those detailed in our earnings release, and our SEC filings and the forward looking statement at the end of this web presentation and referenced in our call today and.
In addition, we refer you to our earnings release and presentation for disclosures and reconciliation of non-GAAP measures, we use when discussing our results.
And as a reminder, you can follow today's broadcast and slide presentation on our website at spirit Aero Dot com.
With that I'd like to turn the call over to our Chief Executive Officer, Tom Gentile.
Thank you Erin and good morning, everyone welcome to Spirit's third quarter earnings call.
Global Air traffic demand continues to make good momentum towards pre pandemic levels, but the lingering impacts of the pandemic are complicating the recovery and creating a challenging economic environment.
The supply side of the aerospace recovery remains in a fragile state while we saw positive earnings from all three of spirits segments for the first time this year our day to day operations continue to face challenges from multiple factors, including volatility in near term production rate schedules.
<unk> chain challenges availability of skilled labor and persistent inflation.
For example, while the headline production rates do not change we have seen delivery schedule changes since last quarter for some programs, including the 767, the <unk> hundred 20, and the <unk> hundred 20, pushing units out of 2022 and putting pressure on free cash flow.
Frequent scheduled changes create challenges for us and our supply chain, while many of our suppliers are performing to expectations. We continue to see disruption in the supply chain, which is causing part shortages in our factories. Several issues are driving the supply chain disruption, including skilled labor shortages attrition part shortages in inflation.
Labor has also been a challenge.
Earlier in the year, we addressed our labor needs by recalling workers. Many of these workers were less experienced and have had a longer learning curve to meet the same levels of productivity as the workers that retired during the pandemic.
As we have gone to the open market to fill new openings, we have seen a higher level of attrition than in the past to mitigate this attrition and attract the skilled labor needed. We have brought on additional contractors have been holding job fairs, we have lengthened our training program and have increased hourly starting wages. In addition, we have even been offering.
Signing bonus for hourly workers of $3000 in Wichita.
These issues schedule changes part shortages labor shortages and attrition and inflation have disrupted our production system in Q3, resulting in lower than expected deliveries, which in turn had a negative impact on our cash flow.
We have put in place plans to address these challenges and we continue to target 300 deliveries for the 787 during the full year 2022 with our team. There is obviously risk to achieving this target, but our team is making a tremendous effort to achieve this delivery schedule. So that we start 2023 and a stronger position.
Right now we are producing the 787 at a rate of 31 aircraft per month.
We expect to be at this rate for much if not most of 2023.
Given the ongoing schedule supply chain and labor challenges that we have been encountering we have launched a cost optimization effort that should enable spirit to be profitable and cash flow positive. When the 737 is at 31 aircraft per month, which is where we are now and may remain for some time.
This cost optimization effort will focus on reducing structural cost at spirit in three major areas operations supply chain and infrastructure overhead.
While our commercial operations are taking more time to recover from the Max grounding and the pandemic our efforts to diversify into defense and space and aftermarket are gaining more traction.
Our defense and space segment grew this quarter its revenue by 17% with 11, 4% margins, we've been able to win more classified defense projects that are important to the new national defense strategy by Repurposing some of our excess widebody capacity to defense applications. So far we are.
<unk> approximately $1 2 million square feet in Wichita to defense business.
Classified programs are early in their development, but will contribute to revenue and profit when they get into full rate production.
In September we were awarded a contract to provide the new horizontal stabilizers for the KC 135 tanker.
We continue to target $1 billion in defence and space revenue by 2025.
The aftermarket business also saw solid growth in Q3.
The segment grew 38% over Q3, 2021 with 24% margins.
We recently signed an Mou with Malaysia Airlines Berhad to established repair services for nacelle and flight control surfaces.
We continue to target $500 million of revenue for our aftermarket business with margins in excess of 20% by 2025.
I'll now turn the call over to Mark to take you through a few more details on our third quarter results Mark.
Thank you Tom and good morning, everyone.
We continue to experience significant pressures this quarter due to lingering impacts of the pandemic, including a very challenged supply chain labor shortages.
Some production schedule volatility and ongoing inflation.
These challenges are not unique to spirit and I'm certain you have heard it from the other earnings calls over the last couple of weeks.
We believe these challenges will continue through 2023, we are taking additional actions like implementing a cost optimization program.
We are slowly starting to see an improvement in our financial metrics.
Revenues were up 30% year over year.
Gross margins were the highest we reported since the pandemic began and most significantly. This is the first time, we've reported positive commercial segment margins since 2019, while operational cash flow has continued to improve due to higher 737 production rates.
Now let me take you through the details of our third quarter financial results.
First let's start with revenue on slide two.
Revenue for the quarter was $1 3 billion up 30% from the same quarter last year.
This improvement was primarily due to higher production on the 737 program and increased aftermarket revenue.
We offset by lower lower production revenue on the 747 program.
Turning to deliveries the narrow body programs in the third quarter of 2022 were 40% higher compared to 2021 with 226 in the third quarter of 2022.
We delivered 22 more 737 units and 40 more <unk> hundred 20 units compared to the third quarter last year.
<unk> body program deliveries were up 11% compared to the third quarter of 2021.
Overall deliveries increased to 316 units compared to 248 in the same period of last year.
Now, let's turn to earnings per share on slide three.
We reported earnings per share of negative $1 22.
Compared to negative $1 <unk> per share in the third quarter of 2021.
Adjusted EPS was negative <unk> 15.
Compared to negative $1 13 in the same period last year.
This quarter's adjusted EPS excludes the deferred tax value Asian allowance as well as costs related to the termination of the pension value plant a while the third quarter 2021 adjusted.
Adjusted EPS excludes the deferred tax asset valuation allowance and a pension curtailment gain.
We continue to experience disruptions in our factories as a result of parts shortages and labor challenges, while continuing to see further inflationary pressures and logistics energy and other indirect areas.
Operating margins were slightly positive compared to negative 16% in the third quarter of 2021.
The margin increase reflects higher production rates, specifically on the 787 program as well as lower forward losses.
And excess capacity cost during the current period.
The quarters forward losses were $49 million, an unfavorable cumulative catch up adjustments were $5 million.
This is compared to $70 million of forward losses, and $3 million of unfavorable cumulative catch up adjustments in the third quarter of 2021.
The current quarter for losses were primarily driven by the <unk> hundred 50, 787, and RMB 30 70 programs.
<unk> hundred 50 charges were a result of additional costs related to labor freight rework and the impact of part shortages.
While the 787 losses were driven by increased supply chain and other costs associated with the ramp up of production in the RB 30, 70 program forward losses were driven by increased engineering cost estimates.
The third quarter 2022 earnings also included $31 million of excess capacity costs.
A decrease of $21 million over the same period of 2021.
Other expense for the third quarter of 2022 was $42 million compared to other income of $90 5 million in the same period last year.
The variance was primarily due to pension plan termination activities that were undertaken separately in each of the third quarters, which drove special accounting impacts in each period.
The third quarter of 2021 included a curtailment gain of $61 million, resulting from the closure of the defined benefit plans acquired as part of the Bombardier acquisition.
In our current period, we terminated the frozen U S pension plan.
Value.
This termination satisfies pension obligations to participants while also eliminating the risk of future market volatility and reducing future compliance and fiduciary obligations.
In relation to this termination we recognized noncash charges of $73 million in the third quarter of this year.
Primarily driven by an enhanced benefit the company is providing to certain U S employees in conjunction with the planned termination.
We also anticipate additional noncash charges over the next few quarters as the plan is finalized.
Once this is completed we expect after tax cash reversion in 2023 in the range of $120 million to $150 million.
Going forward, we anticipate the absence of this plan to reduce noncash pension income by about $30 million annually.
Now turning to free cash flow on slide four.
Cash used in operations for the quarter was $36 million, which includes the quarterly cash repayment of 31 million towards the Boeing 730 advance received in 2019.
Free cash flow usage for the quarter was $73 million, which was higher compared to the same period of 2021.
Driven mainly by large cash items in the third quarter of 2021.
Which included a $228 million tax refund.
$38 million received from the aviation manufacturing jobs protection program.
2022 free cash flow has been and will be negatively impacted by customer deliveries that have been pushed into 2023, particularly on the <unk> hundred 20, and <unk> hundred 20 programs.
Additional headwinds from the foreign losses recognized on the <unk> hundred 50, 787, and RMB 30, 70 in the third quarter as well as ongoing supply chain disruptions labor shortages and inflationary pressures.
As a result, we expect the fourth quarter free cash flow to be between breakeven and negative $75 million.
This estimate along with the $450 million in cash usage through the third quarter.
Resulted in full year free cash flow usage of negative $450 million to $525 million.
Obviously this is an increase from our previous target.
With the majority of the increase due to push out of deliveries into 2023.
With that let's now turn to our cash and debt balances on slide five.
We ended the quarter with $671 million of cash and $3 $8 billion of debt.
Considering the lower production rates, we are seeing in the current plan to stay at <unk> 31 on the 737 program for longer than our previous plan.
We expect that it will take us longer to reduce our debt than originally anticipated.
We now plan to explore refinancing options to provide additional cushion given the uncertain economic environment.
As I mentioned earlier, we also expect to receive the surplus cash from the pension termination in 2023, and we anticipate this amount to be approximately $120 million to $150 million.
Next let's discuss our segment performance on slides six through eight.
This quarter, we saw significant year over year improvements across all three segments as well as sequential improvements across each segment over the second quarter of 2022.
Now, let's get into more detail.
On commercial segment on slide six.
In the third quarter of 2022 commercial revenues increased 32% 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 the 747 operating margin for the quarter increased to positive 4% compared to negative 9% in the same period of 2021.
The improvement was due to higher volumes on the 737 and lower changes in estimates and lower excess capacity costs.
Changes in estimates during the current quarter included forward losses of $47 million, an unfavorable cumulative catch up adjustments of $7 million in comparison. During the same period of 2021, the segment recorded $62 million of forward losses, and $3 million of unfavorable cumulative catch up adjustments the <unk>.
<unk> had excess capacity costs of $30 million compared to $55 million in the same period last year.
Now, let's turn to defense and space on slide seven.
Defence and space revenue improved by 17% compared to the third quarter of 2021 due to increased P. Eight.
CH 53, K production and higher development program activity.
Operating margin for the quarter increased to just under 12% compared to 6% in the same period of 2021 the.
The improvement was due to higher classified program profit and lower forward losses compared to 2021.
Partially offset by higher costs in the current period on the Sikorsky CH 50 <unk> program.
The segment recorded foreign losses.
Favorable cumulative catch up adjustments and excess costs each of $2 million compared to forward losses of $9 million.
Favorable cumulative catch up adjustments of $1 million and excess capacity cost of $2 million in the third quarter of 2021.
For our aftermarket segment results.
Let's turn to slide eight.
Aftermarket revenues were up 38% compared to the same period of 2021, primarily due to higher spare part sales as well as higher maintenance repair and overall activity.
Operating margin for the quarter increased to 24% compared to 14% in 2021 due to higher margins on spare parts sales and MRO activity compared to the same period in the same period in the prior year.
Our aftermarket team continues to win new business and we are pleased to see the continued growth in this segment.
In closing, we remain focused on execution and delivering on our commitments to our customers as we manage through the pressures from the strained supply chain a tight labor market.
Decreased costs and the associated impacts of those pressures to our customer production schedules.
Although the pace isn't as fast as what we would like to see we are on the right trajectory to financial recovery revenues margins and operational cash flow have continued to improve over the last two years and we expect that recovery to continue going forward.
As Tom mentioned, we now expect the 737 programs will remain at a rate of 31 per month for most of 2023.
And as a result, we are initiating a focused effort to enhance our profitability and cash flow in 2023.
This program will have a dedicated team focusing on reducing structural costs in the areas of operations supply chain and overhead.
As we look to 2023, we continue to expect free cash flow to be positive and we plan on sharing more details at our next earnings call in February .
Now, let me turn it back over to Tom for some closing comments.
Thanks, Mark it was a challenging quarter, but we were pleased to see some positive results, which will provide a foundation for a strong future outlook.
Overall revenue was up 30% year over year, mostly on 737 deliveries, which were <unk> 69, this quarter versus <unk> 47, a year ago.
Defence revenue was up 17% year over year with 11% operating margins aftermarket revenue was up 38% with 24% operating margins.
This quarter, we had the first positive operating income in three years of $5 million and it was the highest segment operating margin in three years at six 5%.
These positive results are encouraging, especially since the adverse impact of the pandemic is lingering far longer than we all expected.
Main challenges we have seen are similar to what other companies are experiencing.
Unstable schedules from customers in a very dynamic environment, even when headline production rates do not change supply chain disruption, resulting in part shortages for our factories labor shortages and elevated levels of attrition and high levels of inflation.
We expect some of these challenges to continue into 2023.
We are therefore, taking several actions to position spirit to be profitable and cash flow positive even if production rates on the 737 remain longer than we expect at 31 aircraft per month.
These three major actions to reinforce our performance in 2023 are the following.
First launching a cost optimization effort to remove structural costs and infrastructure supply chain and operations that will ensure that spirit is profitable and cash flow positive at 31 aircraft per month, if that rate ends up being where we stay for an extended period of time.
Second exploring refinancing options to provide additional cushion given the uncertain economic environment, we are not planning to issue equity.
And third completing the process of our U S pension plan termination, which will revert between $120 million and $150 million of cash in 2023.
With that we'll be happy to take your questions.
If you'd like to ask your question. Please dial star followed by one now and again in the interest of time, please limit yourself to just one question.
Our first question will be from the line of Greg Conrad from Jefferies. Please go ahead.
Good morning.
Maybe just wanted to.
Todd.
Just starting on the puts and takes for Q4 free cash flow at the lower end of the usage. It kind of matches Q3 with based on the 300, a pretty big step up in 737, Max deliveries. How do you think about the puts and takes and how you're thinking about these items into 2023.
Right well the key of course for cash flow.
Both in Q4 and in 2023 is going to be deliveries of all programs, but particularly the 787, Max and so as I mentioned in my my remarks, our target is still 300, which means we have about 100 more to go in Q4 and the team is focused on that that will obviously drive better cash flow.
And looking at next year as I said, we're planning to stay at 31 aircraft per month and executing on that stabilizing our factories stabilizing the supply chain getting working capital under control and so that will be a key driver for next year.
On free cash flow.
Thank you.
Our next question is from the line of <unk> <unk> of Jpmorgan. Please go ahead.
Thanks, very much and good morning.
I guess when you talk about next year.
And being free.
Free cash flow positive next year would that be free cash flow positive before the let's call it $135 million.
From the pension coming back.
And then also when we talk about exploring refinancing options is that is that just right now about the next year's maturity or is it something more more comprehensive.
Right well the answer on the first question is yes that we expect to be free cash flow positive.
Even without the $120 million to $150 million reversion from the pension termination.
And then secondly in terms of.
The debt.
Your second question again, Seth was one so on the roofing just about the refinancing.
Yeah. So Seth we're just exploring all options I would say that.
We're looking at it Holistically and so at this point in time, where we're not really kind of narrowing it in to any one specific maturity. We're just looking at the backdrop of our current macroeconomic environment. We're looking at the fact that 737 production rates are going to be longer lower for longer.
So we are evaluating the.
Our entire situation, we're evaluating the capital market environment.
We will be making some decisions.
Shortly.
Okay, Erica thanks very much.
And our next question is from the line of Robert Spingarn of Melius Research. Please go ahead.
Hey, good morning.
Tom if I can have good morning for you one short term and one long term.
What is it about Q3 that all of a sudden we're seeing significant movement in the in the rate assumptions. It sounds like you all were.
You've changed since Q2 on this 31 and I imagine that's because of what Boeing said and so why all of a sudden the change in the plan not just there but on the $3 20, and the $2 20, what happened between July and now in the supply chain.
And then a longer term question is the second question you haven't had much time to think about this but now that Boeing has given us numbers for 25 and 26.
For their own financials and on rate. So 50 for the Max 10 on the 87 you already have an Airbus plan for then can you come back to us with a plan for spirit in those years.
Okay, well, let me do the first question first on the short term in terms of the rate assumption. So, let's just start with Max.
Or just right now getting some greater clarity from from our customer Boeing in terms of what their outlook is they gave a little bit more detail yesterday in their investor day, and so we're solidifying our plans as we look at it. We've always said, we want a trail them a little bit. So we can burn off some of this inventory that we built up during the Max grounding and the pandemic.
And that Hasnt Hasnt really started yet so as we look at next year. They said theyre going to be at 31 for an extended period of time, So we will as well and we will just watch their increases and we'll trail along accordingly, we still have a buffer this quarter was about 75 units.
Or is it actually 72 units, whereas last quarter. It was 66 units. So it actually grew a little bit this quarter.
So thats the situation on 737, Max with regard to the $3 20 in the 220, it really wasn't necessarily anything to do with the supply chain. It was more just Airbus, making some decisions to move units out of the year. So the production rate didn't change, but they just moved units out of the year that we won't deliver and that was the update really.
In terms of those programs.
I mentioned that in my remarks, it was the headline production rates didn't change, but the number of units that we deliver did because they moved them out of the year.
So that is it seems like everything's.
Tied to production rates and they are volatile and they are all over the place I mean, I heard a lot of different production rates when I was out in Seattle in the past two days and just.
Just seems like there's still quite a bit going on in the supply chain that prevents visibility for all of you.
I think that's a fair fair comment, it's a very dynamic environment and things are moving around and one thing Balling mentioned yesterday as they want to stabilize everything at the current production rates before they make decisions about going up in an Airbus really wants to ensure that everything is stable as well and they have very as you know.
<unk> rate increases over the next few years.
So we want to make sure that we are meeting the requirements.
I was just kind of it just seems like you were all you all felt more comfortable with this three months ago than you do now.
I'd say the dynamic environment in some of the uncertainty continues to play a part it was a dynamic dynamic quarter for the reasons I mentioned part shortages.
Mission and inflation.
So on a longer term, yes, you said that Boeing has outlined some of their targets for rates on 737, Max and $25 26 for 50, and then 707 to 10 and yes that gives us some more clarity now and we can take that information and incorporate it into our current forward looking planning and start to come up with some outlooks for those years as well.
Obviously, we haven't had time to do it in the 24 hours since we learned about it but.
We'll be using that information.
Yes.
Mark I think the market would appreciate that thanks, so much.
Okay got it thank you.
Our next question is from the line of Cai von <unk> from Cowen. Please go ahead now.
Yes. Thank you so much so.
Your target is 100.
730 sevens in the fourth quarter, that's way above anything that you've done what kind of challenge is there to get that is your cash flow guide based on getting there and if you Miss.
How should we think about.
Per unit.
What that means in terms of cash flow shortfall.
Right. It is higher than we delivered in the recent past.
We've been working up to it with all of the changes and improvements and additions that we've been making over the course of the last year. So for example, we have been continuing to hire new staff. We have brought on new contractors. We continue to incorporate the benefits of some of the Digitization automation and lean process flow changes that we've made in the <unk>.
Plants and so all of those things are are starting to come into into four. We've also started to see some sort of stabilization in some of the park shortages. There is still some part shortages, but it's stabilizing and we feel like we can have a good control of it. So that's why we set that target and we are tracking to it right.
Now now there is a risk that we might miss some of those deliveries and that was why when Mark said the guidance for Q4. He gave the range of zero to negative 75 to take into account that if.
If we execute on all of them, we would be at the higher end of that range and if we miss some we would be towards the lower end of the range Mark anything else to add.
No I think you said it right.
I would prefer not to give you such a wide range in the fourth quarter.
But as Tom said, there continues to be part shortages. We've got a few very critical suppliers that were depending on to make these deliveries in the fourth quarter.
And if we can't get the parts and we don't deliver that means I can't turnaround in and build a customer and collect the cash.
So we're going to fight through it over the next couple of months.
And so that's the range, where we have if we end up not being able to make those deliveries. This year. They fall into next year that just means it's a timing situation that cash ends up we collect the cash in 'twenty three as opposed to this year.
I'd say over the course of the last couple of quarters, we've been working toward getting to 31 aircraft per month and stabilizing at that level. So we're currently.
Operating the plant at 31 aircraft per month, we remain on the plan that we outlined for Q4, there are lots of challenges, but we're confident that the team is now performing and executing at its highest level.
For the last several quarters.
But I don't understand so 31 per month, basically equals 93, Youre talking 100, Youre talking more so are there some that essentially have been built that you would complete because of 100.
As I said again is is a pretty aggressive number given where you've been.
Yes.
Actual rate has a little bit higher than 31% in terms of where we cycle. So that accounts for some of it.
Have some overtime built into that and yes, there were about eight or so eight or 10 units that were not delivered in Q2 that is carried over to Q3 and so we finish those up in the very early part of Q4. They didn't finish in Q3. So so it's all of those factors that give us confidence that we can hit the target now theres some risk to it.
But that's what the plan is and that's what the team is executing too.
Very helpful. Thanks, so much.
Our next question.
<unk> of Bernstein. Please go ahead.
Yes. Good morning, Thank you.
On the you talked about.
Next year.
Really pushing through a cost reduction effort, but given that.
We've gone through the pandemic, clearly you and others to everyone had to reduce a lot of cost there.
How do you envision taking cost out from here and there.
And with that.
If we see a rate go up which we expect we will it's not clear exactly when.
How do you make sure you haven't cut too much. So we don't end up back in the same kind of situation that a lot of suppliers are in.
Before when demand picked up.
Right.
A few things Doug first of all on SG&A, we've got to make sure that we align the cost of all the indirect costs to the production levels that we have not necessarily higher production levels that we may have anticipated.
We want to continue to optimize those costs and make sure we are getting them at the most competitive rates. So for example, a lot of our indirect sourcing and purchased services were taking a hard look at those types of costs to make sure that we are controlling them. The other thing is is supply chain and there what we're looking.
At really is level loading the system in the optimal way is figuring out where are the pockets of capacity and labor that exist in our more competitive cost and how can we move that around the supply chain, including how can we take some of the things that we have brought in during the pandemic how can we push that back out.
To the supply chain and get more cost benefits.
And looking at a whole range of different options with the supply chain to level load the system and an overall create more optimal pricing.
And then the third thing is in operations is continuing to leverage the investments that we've made over the last couple of years in things like Digitization automation and lean factory flow and capturing those benefits to drive improvements in realization and productivity on the factory floor to get more cost.
Also look at for example, our R&D is how can we get better benefits from the R&D not so much in terms of necessarily reducing the R&D, but perhaps shifting some of it from.
Things that are further out to two R&D efforts that will deliver productivity benefits more in the near term. So we have what we call horizon, one horizon two horizon three will be shifting some out of horizon three into horizon one.
And then the last area is things like capital expenditures is again looking at those capital expenditures and saying well what's absolutely critical.
Can we.
Potentially pushed out or stop in order to improve the outlook for 2023. So it's that combination of activities that will drive the benefits in overhead and supply chain and operations Mark anything else to add.
No I.
Thank you covered it Doug.
We're not really going to.
Be aggressive on the factory specific assemblers et cetera. There are many things that we're working on around outsourcing transactional type work, we're looking at combining some administrative functions across some of our sites. These are some things that with production volumes being lower for longer.
We could afford some of that in the past, but at this point in time, we can't and so these are some real structural things that we're going to do.
But be very very mindful that we don't have a negative impact on our ability to deliver there are some some some of our sites. There are some some factories that.
Our over utilized we'd have to do some consolidations. So it's those types of things and we're at this point in time, we have to aggressively go at it it will help us improve our overall margins and it will improve the cash flow projections that we have so we're taking it serious we're doing it in a way.
To make sure that we protect the factory, but there is some some costs out there that we need to go get in fact and due to the fact that production rates arent recovering as quickly as possible.
But if I can.
Boeing.
Said yesterday that they looked at this 31 months right through the next year, but.
Depending how things go in the supply chain, particularly with engines.
At some point could go up to 38.
When you look at that and <unk> been going through this for a while this uncertainty of when that next rate break would be.
How much lead time do you need to take rate up.
Knowing where to say, they're not going to do it but I wanted to say tomorrow, we're going to 38.
Q2 or something like that.
Great.
As we've said before we usually like to get six months of lead time on a rate increase and we are very mindful that we need to make sure we deliver and meet the rate expectations of our customers and so we're working closely with them. We are watching it and we're not going to do anything in terms of our cost optimization project that would hinder us or prevent us from meeting the rate expectations.
Of our of our partners, but generally speaking we like to have a six month notice and we're confident that working with Boeing we will have at least that if there is a rate increase in 2023, yes, I would just add.
That was historically true with the macroeconomic environment labor shortages attrition.
We have to do this thoughtfully, we don't want to put ourselves in position where were we.
We have a negative impact of the factory so definitely contractual commitments of six six months, but in light of the current environment. We're trying to work with Boeing on six to eight months lead time right, let's make sure that we protect the production system, we hired the people we place the orders.
Do it in a very thoughtful way so that we can execute this in a manner that really help support the airlines, but also protects our profitability.
Great. Thank you.
Our next question is from George Shapiro from Shapiro Research. Please go ahead.
Yes.
Yes, good morning.
Mark I just wanted to go back and get some color as to why cash flow got so much worse and could it happen next year because like in the Q4 call that occurred only back in February .
Guide was for effectively minus $120 million, including the cash payment to Boeing and obviously you gave the numbers this morning.
So when you look at that clear deterioration in like eight months.
What was the biggest drivers for it.
George I think we've tried to convey this.
The production schedules.
Delivery assumptions right. We started the year expecting 350 737 deliveries, it's 350 units.
The amount of content and revenue and cash that's generated from that program is significant when.
When we look at the deliveries on <unk> hundred 20, and where they are we just talked about Airbus sliding out.
Close to 30 units on us either within their supply window of 30 days.
<unk> hundred 20 program.
The Oems are being challenged.
Theyre seeing some supply chain challenges, they're seeing engine shortages all of this stuff rolls down to the tier one right and we're trying to react to it as quickly as we can but.
George you have been in this business a long time. This is a long cycled very complicated manufacturing process long lead times and so when we gear up the system to go produce and hire people and bring in inventory to support certain production rates and those production rates change in short order.
It's very difficult for us to pivot as quickly as that can be and so what I would tell you is this the one lesson learned for me is to be very cautious about those production rates and what people are saying about the increase and therefore as we think about 2023 trying to take those lessons learned and the comments that Tom.
Talking about is.
Our expectation is we're going to be a 31, right, we're not expecting and planning financially to do any better than that and so from a financial planning standpoint, we have to assume that these production rates are going to be close to where we are now right. We've got to get the factories healthy and we can anticipate.
Get these things going up until there is clear line of sight to it and so.
We've been through <unk>.
Several cycles in the last 10 years production rate climbs and I've been here over 16 years and I can tell you the challenges, we're seeing with labor and supply chain right and the inflation.
Is.
Putting way more pressure on the production system, even when we went from 42 up to 52, its challenging environment out there and it's putting a lot of pressure on our ability to produce its putting a lot of pressure on our ability to generate cash we've got a carry extra inventory buffers because of supply chain I would just.
It's not a stable environment.
And right now collectively spirit the Oems, we have to get the factory stable, we have to start delivering at 31 a month.
Consistently and when that happens youll start to see the earnings and the cash flow generation come through and George what I would I would say as the recovery has just been more uncertain than any of US expected. We've seen multiple schedule changes really in and all the programs pushing things out.
Further than we had anticipated so that's the biggest driver by far.
Okay, and let me just kind of pushed us towards 23 for a minute.
The 31 rate Youre, obviously going to deliver like 370, 730 Sevens next year only 20 more than what you expected to deliver early this year when the cash is going to be negative 120, and now you're saying there's going to be positive next year. I mean, you get positive just from 'twenty more three seven deliveries.
Next year versus whats your expectation was from earlier this year.
George remember the negative 120 included the repayment of the Boeing advances of $130 million.
Right, yes so.
You wouldn't have included those.
Right.
If you would not include that you excluded.
And that would set at 350 730 sevens, we would've expected to be positive.
Yes breakeven is what you said.
But okay, but rajiv slightly positive.
Okay.
Yeah.
And for 23 of the extra 20 deliveries gets you to say you are quite positive.
The 120 to 150 million <unk>.
<unk> benefit youre going to get.
We haven't told you figure out what we.
<unk>.
We haven't said how cash positive we said we would be cash flow positive in 2023, excluding the pension cash reversion and that we would provide more specifics in February when we have a better line of sight to what our production schedules are going to be.
Okay.
Thanks for the color.
Thank you.
And our next question is from the line of Cristina <unk> of Morgan Stanley . Please go ahead.
Hey, good morning, guys.
Good morning.
Our production rates I mean, Tom you alluded to that you heard about the new 787 production rate 24 hours ago, when they released it to investors.
In the past few quarters.
It seems like the production rate guide down continues to be a surprise I guess I would've assumed that you are in closer discussion with Boeing that would be part of their planning process.
Does this surprise normal or is there something going on that you.
Youre not more in line with their planning process.
We obviously talked to Boeing every single day about production schedules and we have plans that are in place and scenarios. What I was saying is just their public announcements I mean, obviously, we have the schedules that are in place and the interactions that take place, but it's been dynamic.
As I said production schedules have changed in the last 14 months or so we've had several different production schedule changes on the 737 at the at the highest level, but also in terms of the minor model. It's a very dynamic environment, it's changing on a weekly basis.
And so that's what I meant by that and not to say that we are just learning now what the outlook is we obviously have production rate scenarios that we have been working with and a lot of detail and Thats. Why we are confident that whatever Boeing does we will be able to adapt to meet it because we are in constant discussion with them and we have good outlooks and we're constantly looking at different scenarios.
I see that's really helpful color and then if I could clarify.
One thing you guys mentioned before 2023 it seemed like.
Your previous outlook when it would be positive free cash flow was predicated on higher production rate. So is that and I know you guys said that you will you will provide more details next quarter, but now would be maintaining that positive free cash flow in 'twenty three on lower production rate does that imply that you expect to get that from the cost initiatives.
Sure.
Can you give us a few moving pieces and how you get there.
Alright, well, we always said, we would aspire to be cash flow breakeven essentially at 31, and what we're saying now is since we expect to be at 31 longer we want to take actions to enhance our profitability put ourselves in a position to be more cash flow positive and more profitable. If we stay at 31 longer and the things that we're going to do.
The things that I mentioned earlier in terms of our operations as we will look to.
Incorporate and get the benefit of some of the investments we've made in Digitization automation and flow in terms of overhead we will look at consolidating.
<unk>, where it's underutilized.
Sure.
Aligning costs between sites and a more efficient way.
Looking harder at indirect costs, and and purchase services and making sure those are aligned to production.
And then in the supply chain, it's really looking at level loading to figure out how we can get the best cost position and go to where the capacity exists in terms of people and in infrastructure.
Because there are shortages in different pockets and we've got a level of the system. So that we can optimize that better and those are the things that we would do to be more profitable and more cash flow positive at 31 aircraft per month now we say 31 aircraft per month, we use the Max is just a proxy for the whole system, but obviously all of the programs contribute to it it's just that.
The Max is still our biggest program and so we always use that as a proxy.
Kristina the only other item I would just add is we're coming off a pretty challenging third quarter.
Deliveries arent.
Didn't really hit where we expected due to all the factors that we just talked about and when you look at cash from ops. It was a consumption of $36 million $31 million of that was the Boeing advance repayment, so operationally and working capital wise from a cash from ops standpoint, we were almost break.
Even in a very challenging quarter. So I think those demonstrate the trends that we're seeing the improvements that we're seeing in our in our cash position and our cost structure, you're seeing significantly lower excess costs and so you look at last quarter. The cash from ops you look at this quarter and then the guide that we're providing you see.
You are seeing a very very favorable trend right and getting very close to breakeven cash flow from ops.
Even during the challenging times at this 31, a month and as we get stable and we drive into next year, that's what what gives us.
A pretty good feeling that at stable 31, a month, we can drive cash flow positive this into our into our operations.
Take advantage of the cost optimization program.
Who knows maybe late next year, a little higher production rate will be additive to that but that's kind of how we're thinking about it.
That's really helpful. Marc and thanks, Tom I appreciate the time.
Thank you. Thank you.
The next question is from the line of David Strauss of Barclays. Please go ahead.
Thanks, Jim.
Just a follow up on this line of questioning.
Helping us think about bridging.
This year, Ted Max share on free cash flow is really the <unk>.
$4 $50 million to $500 million positive change I guess less less the advance.
Advanced payments and is that really almost all Max.
Max rates stabilize near 31, a month is there anything else. We should know about in terms of that bridge and then as a follow up question Mark.
The refinancing is an equity raise on the table or are you solely focused on.
Refinance down the fixed income side.
Yeah. So second the second item first.
We're not exploring an equity raise.
At this stage of the game with where our stock prices that would not be fair to our investors. There are some other opportunities we have.
From a refinancing.
Standpoint, the capital markets are available to a company like spirit.
No.
At this point in time.
Looking at equity raise when you think about the cash flow David.
And I know, what the math Youre doing youre, saying, hey, $4 50, minus the 130 year at $3 20, right and so is that $320 million improvement between 'twenty, two and 'twenty three all 737.
It's more complicated than that okay. At the start of this year. We were at 21 aircraft per month right. We broke right we had to bring in additional inventory we've seen a whole lot of disruption.
Higher costs.
Earlier in the year that had a significant negative impact to cash flow in the first quarter and a lot of that was.
I would just say cost that were consumed to break rate from 21% to 31 that won't repeat so I think you have a couple of things going on as you move into 2023.
The what I would call the cost the inefficiency costs that occur when you go up in rate hiring people ahead of time learning curve et cetera, those costs won't repeat if we stay and get stable at 31 for a longer period of time the second component is.
Theoretically we go up 70 75 units on 737 very helpful from a revenue earnings and cash flow standpoint, I will also tell you that we're expecting higher deliveries on the <unk> hundred 20 program. Another very good program for US a solid program and.
And so we're seeing an uptick in several of our other programs higher revenue on defense higher revenue on aftermarket all of those things are contributors to the cash flow and if we can get things stable from a factory standpoint, then we have an opportunity to start to burn down some inventory not bring in the buffer inventory that is needed.
During this challenging time, so I think that the combination of all those factors right.
Lead us to believe that.
Ex the Boeing repayments that we can take that negative $3 20 that was that occurred here in 2022 and that in turn that around to being positive and again, we will come back and talk more specifically about how much how more positive cannot be give us a little time to dial in.
Our our production rates for next year, let us take a couple of more months to work through the disruption of our factories to try to get things a little bit more stable and we will have a better line of sight on that in a few months.
Okay, and how does the four loss burn off on the on the $3 58, 7% to 20 factor and all of this I mean, you burn a lot of cash on those this year just looking at the burn down of forward loss balance.
That a negative the next year given higher rates, there or is that is that neutral.
Well, what I would tell you is our cash forecasting we well aware of the fact that we have multiple programs in a forward loss. We know specifically based on our forward cost projections exactly how much cash they will consume in 'twenty three 'twenty four 'twenty five give or take some of the recent four losses going.
Put a little bit of pressure on that.
But.
Based on our current situation with the forward losses that we've taken here through the third quarter and our projected cost versus price in 2023 that is factored into our assumptions that we can get to cash flow positive.
Thank you.
Yeah.
Our next question is from a line of Myles Walton of Wolfe Research. Please go ahead Matt.
Thanks, Good morning.
There was a comment that Boeing made yesterday on on to quality slips at their fuselage supplier in October that was preventing deliveries at pace in this crime rework I'm just curious if that is.
Something that happened at spirit and as it recovered and is there a financial impact that was observed in a third or will be observed in the fourth quarter.
Yes.
Yes.
So fuselage and all of our parts that go to Boeing across a different programs.
There are occasionally some escapes either from things that we do are from our suppliers I think the one that Stan was referring to was a supplier of escape to us that ended up getting to Boeing and if you think about it there is 80000 parts in a few slides and 450000 fasteners.
It can't happen.
It's not routine, but we do see escapes and we work with Boeing to get those fixed so it's nothing systemic I think it was isolated to one of our suppliers, who had an escape in their factory, which unfortunately flowed through to Boeing and we're working with them to resolve it.
And so that was the impact observed in the third quarter deliveries or will it be observed in the fourth quarter deliveries and to <unk> point.
Yeah, I mean I think.
I don't know specifically in the airline but it is something that we don't expect is going to persist all the way through the fourth quarter. So it would it would get resolved as these things normally do.
<unk>.
In a period measured in days and weeks not months.
Okay. Okay, all right I'll call. This a routine escape that we will resolve with Boeing.
Got it thanks again.
Our next question comes from micro Simonyi of <unk> Securities. Please go ahead.
Hey, good morning, guys. Thanks for taking the question.
Just curious again staying on the free cash flow as we think about 31, a month into next year, where do you think the excess capacity costs track, two especially contemplating the cost reduction plan and then just I guess you made some comments on 'twenty five for aftermarket and defer.
Fence relative to the Investor day should we still be thinking the commercial targets are still good or does anything change with Boeing being at 50 in.
<unk> 10 for the 787.
Yes.
Yes.
Alright, well in terms of.
The excess costs I'll leave that one for Marc Let me just talk about the 25 outlook.
Again, we were anticipating that the 737 rates would go up we are anticipating the 787 rates will go up I think Boeing has been more clear publicly now about those and so we will incorporate those into our thinking and start to think about how that impacts 25 and 26.
But.
It's consistent with what the scenarios, where that we have been working with so no surprises on that.
Mark on the 31 excess cost I'll, let you answer that because its an accounting issue.
Yes, we've talked about this before just to give you a little history in 2020, we incurred $280 million of excess costs in 2021.
It's $218 million of costs through the first three quarters, we're at $126 million.
And we incurred around $31 million in the third quarter.
Based on the 31.
Month production rate as well as a couple of other programs that are have excess costs, we expect the excess cost again to significantly improved year over year.
We expect that to.
It should end up being slightly inside of a $100 million. So another nice nice benefit from an earnings and from a cash flow standpoint, and I would say that the positive about the Max going up to 50 in the 25 timeframe and Airbus has already said they want the <unk> hundred 20 family to be in the 75 range.
That will be very positive for spirit, 85% of our backlog is narrow body aircraft and as we get back to those rates as we get back up to 52 towards 52 on the Max for example, the excess cost will go away and we will be absorbing a lot better in terms of our fixed costs and that will drive overall benefits for for spirit. So that's.
I think one positive aspect of the recovery is that domestic travel is recovering first that favors narrow body production, 85% of our backlog is narrow bodies and as those production rates increase on narrow bodies and we can absorb more of our fixed cost and drive productivity and efficiency in our factories that will be very positive for our productivity.
Our profitability and our cash flow.
Got it thanks guys.
Thanks, Michael.
Our next question comes from line of Ron Epstein of Bank of America. Please go ahead.
Yeah.
Ronny there.
Yes, sorry, I was on mute.
Yes, that's right.
Mess it up anyway.
Questions quick ones.
How cash accretive as your defense business today, when we think about how supportive of that can be.
Your cash flow outlook, and how do you guys feel about the 7% to 9%.
Our cash flow guidance that your target that you gave before.
Right well in terms of defense as we've said.
We expect that it could be at $1 billion by 2025 at we call it normal defense margins of 12% to 14%.
And there is some obviously some overhead on that but its still would yield a very good cash profile. So the defense business is a good solid business for us. It is growing nicely. We've won a lot of new programs and as those get into full rate production that will drive those those economics, and obviously with the global geopolitical environment right.
Now defense looks like a very good place for us to be growing and diversifying.
With regard to the 7% to 9%.
That's been our historic target, we've talked about it I mean, obviously in the last 24 months. The environment has changed a lot in terms of inflation interest rates going up.
And a lot of other challenges in the supply chain. So we will take a look at that and absorb it and incorporate some of that thinking is before we set targets, but things have changed I mean, our aspiration is obviously as production rates increase to improve our profitability and our margins and our cash flow conversion, but we also have to take into account.
It's a much different macroeconomic environment than even it was 12 months ago, Mark anything else to add no I think youre right.
Ron we've got to get stable, we got to get stable at 31, a month first step first start.
Start generating positive cash flow once we get a better line of sight into 'twenty four 'twenty five where those production rates are.
And where the macroeconomic environment is I think we will be able to better discuss that at this point in time.
I don't have a crystal ball thats good enough.
Where production rates are going to be and what the macroeconomic.
The economic environment will look like during that time.
But that's what we were able to demonstrate in the past right and so were fundamentally the same company.
Stronger defense business stronger aftermarket business and so we're very focused on execution getting stable and then getting back to the type of margins and cash flow that you guys saw back in 2018 to 2019.
Got it got it and then if I may maybe just one more.
Broad question.
And this is maybe an observation might be wrong.
From borrowings holds the world yesterday.
It seems like theyre going to be more protective of their balance sheet.
And if that's the case kind of implies they're going to be less protective of other.
Balance sheets, maybe.
And their supply chain I mean, how does that complicate your life if at all.
Okay.
Well I would just say.
My response to that is we need to be prepared for lower for staying.
For us taking a longer timeframe to get back to the higher production rates, that's what I'm interpreting.
And that's exactly why we're launching this cost optimization program is to take control of what we control and not worry about the things that we can't control are beyond what we can control.
So if we're going to get 31 longer then we will make sure we can enhance our ability to be profitable and cash flow positive at 31.
Got it got it that makes sense alright, thank you very much.
Thank you. Thanks, Sean our next question is from the line of Noah <unk> of.
Goldman Sachs. Please go ahead.
Hello, everyone.
Hey, Noah.
How can you talk about how you expect your.
Max.
Units.
I believe you said is now 72.
How do you expect that to progress from here and where do you expect it to me.
<unk>.
Next year.
Right well as we've said over time as the recovery continues.
At some point, we will trail Boeing.
Five units or so a month in order to burn off the excess units now some of the units.
Sure.
Still in I would say holding pattern.
So there's some China units for example, and so we expect that that will burn off as Boeing goes up in rate. We will we will lag them and that gives us a little bit more time to stabilize our factory. So that's all a positive. The other thing is that we've said this before is the buffers actually turned out to be a very good and help.
Full thing for both Boeing and spirit.
Because it allows us to have a cushion in the production system to prevent any sort of last minute issues impacting loads at the Renton factory and so we've jointly agreed with Boeing is that we will keep a buffer in place.
We expect that to be about 20 units or so.
And that will be a permanent buffer that will help cushion the production system and we didn't have that in place back in the 2018 2019 time period and it could sometimes create disruption. So we know there are some some challenges in the production system ongoing some things that happen.
Right before delivery.
And so that permanent buffer will help cushion the production system. So we're at 72 now.
We will keep a permanent buffer of 'twenty, which means that we'd want to burn off about 50, and then there are some that I said that are kind of in a holding pattern.
And so that's the that's the situation on the buffer right now yes.
No I would just say this noah.
It's probably for your modeling purposes, because youre kind of talking specifically about 2023.
We're at 31 a month.
I don't anticipate us going below 31 months.
Not in the cards and based on Boeing's conversation yesterday about they want to get stable at 31 months.
Those two conversations just would lead you to believe that we're not going to burn a lot off next year, which means our production of 31 and their production and <unk> 31 for the most of the year, which mean would mean that there probably wouldn't be a significant reduction in the burn off of the buffer units next year, which would mean that our buffer would probably continue.
Beyond that into 2024 at some point in time so.
I think based on what we told you about staying at 31 for most of next year and what Boeing said yesterday I just think from a modeling standpoint.
Those are those are two data points to take into consideration.
So basically whenever they break to 38.
You will then have.
Call. It four to six months of staying at 31 to get to get to 720.
We don't necessarily burn it all off at once so we may we may lag them a couple of months when they go to 38, and then maybe a couple of months when they go to 42.
With the plan of burning the buffer I'll congratulate.
There's no time pressure to burn it off and it's actually providing a good cushion to the production system. So it's serving a good purpose right now.
Okay.
Can you quantify.
The cost optimization for next year.
Not not yet we're working on that we'll have more to say at the February earnings call.
And will any of that.
Last into your longer term margins or should we consider the vast majority of that to be variable and then eventually it comes back.
Well the idea is to improve the reduce the structural costs, which ultimately will help margins now I know, you're probably thinking does that mean near 65% target would go up well don't forget theres lots of headwinds and you always have to run fast to stand still and so.
I don't it will help the long term obviously it wont necessarily help US go beyond the 16, 5%, we would still have a long way to go to get there given all of the other pressures like inflation that we're seeing right now in the macroeconomic environment.
But it certainly will help thank you.
Alright, Thanks Noah.
And our last question for today comes from the line of Pizza Ahmed of Baird.
Please go ahead now.
Yes, Thanks, good morning, Tom and Mark.
Hey, Tom.
Both mentioned several times about just the ongoing labor shortage and you've talked about this for a while.
Maybe you could just update us on where head count stands in Wichita, and what what you have to kind of get to I guess for beyond right 30 111.
Whenever it occurs for you to kind of.
Be able to kind of.
All the all the targets that you've kind of laid out longer term. Thanks.
Right so yes.
The issue is that.
It's as we have started to go up in rate we've had to bring more people on so for example, we have about 11000 people in Wichita right now and we've recalled this year in Wichita about 470 people.
But yet we've hired in Wichita over 900.
New people and so that gives you just an order of magnitude of roughly <unk> 300, new people, but 19 500 of those were.
New hires and what we're seeing is based on history. The level of attrition is just higher.
In the past I mean, it's it's gone from about 9% to 12% overall, but what we're seeing is some of the new hires, particularly the entry level mechanic positions.
The attrition rates actually been even a little bit higher than that and so that's that kind of took a little bit of us to adjust to that higher level of attrition.
During Q2 and Q3, we had ended up having to hire more I think we are starting to stabilize now we understand it better.
But those are the dynamics.
We've hired now globally over 3200, new people globally and 1900 of those in Wichita.
And with the higher levels of attrition, it's meaning that we've had to go back and in higher even more but those are the dynamics.
It's a dynamic environment out there as I said in Wichita, we actually had to increase our starting hourly wage and we're even offering a signing bonus.
That's helping the job fairs are helping and we are getting to the point, where we're stabilizing at 31, and we will continue to work on that as we anticipate higher rates in the future.
Okay, and just a clarification and Mark maybe if you haven't just.
You remember what you wear it back and staffing levels in Wichita back in 2018 in terms of total employment.
I don't have that Peter.
We'll get that number and get it out rather than just gas I mean, I have a rough approximation, but I don't want to give you a number that's not completely accurate.
It was higher than that.
11000 that I just quoted it's in our 10-K will get that out okay.
I appreciate all details guys. Thanks.
Okay. Thank you.
Ladies and gentlemen, this concludes the spirit Aerosystems Holdings third quarter 2022 earnings Conference call. Thank you for joining and you may now disconnect your lines.
Okay.
Yes.
Yeah.