Q2 2023 Spirit AeroSystems Holdings Inc Earnings Call
Good morning, ladies and gentlemen, and welcome to Spirit Aerosystems Holdings, Inc. 's second quarter 'twenty 'twenty Free earnings Conference call. My name is Jordan and I'll be your coordinator today, if you'd like to register and would your question you may do so by pressing star followed by one on <unk>.
Your telephone keypad, we also to all participants please limit themselves to one question.
I'd now like to turn the presentation over to Ryan Avey Senior director of Investor Relations and S. DNA. Please proceed.
Thank you Jordan and good morning, everyone I'm, Ryan Avey and with me today are Spirit's, President and Chief Executive Officer Thompson T. Lee Senior Vice President and Chief Financial Officer, Mark such and ski and President of commercial and Chief operating Officer, Sam Arctic.
Before we begin I need to remind you that any projections or goals. We may include in our discussion today are likely to involve risks, including those detailed in our earnings release, and our SEC filings and in the forward looking statement at the end of this web presentation. In addition, we refer you to our earnings release and presentation for disclosures and reconciliation of non-GAAP measures, we use when discussing our results with that I'd like to turn the <unk>.
All over to our Chief Executive Officer, Tom Gentile. Thank.
Thank you Ryan and good morning, everyone welcome to Spirit's second quarter results call I'll begin today by discussing the iam contract and providing an update on the 737 vertical fin attach fitting progress.
On the Iam contract. We are very pleased to have in place a four year contract with our iam represented employees, which reflects the gratitude we have for their contributions while the first vote resulted in a work stoppage. We quickly went back to the table with our Union partners and reached a resolution.
Due to the work stoppage from the strike, we now expect to deliver between 370 and 390 737 fuselages this year.
The front of our production line is starting to break to 42 airplanes per month in August , but we won't be able to fully recover the lost manufacturing days from the work stoppage and the subsequent resumption of full production at our Wichita site.
Mark will walk you through some of the financial impacts related to the new contract and work stoppage in his comments.
On the vertical fin attach fittings.
First all the rework on the available 737 fuselages in Wichita was completed during the second quarter, which was ahead of the timeline, we provided on our last call and within the financial estimates that we provided.
We were quickly able to develop a repair process and prioritize the rework I want to recognize our operations team for the incredible effort. They made to develop the repair implemented and maintain the schedule and budget.
With regards to the units at Boeing we have also recorded a provisional liability in the second quarter related to a potential claim for the repair work performed to date at Boeing. Additionally, we do not expect a material financial impact associated with previously delivered airplanes in the fleet.
Now turning to our commercial business.
<unk> Air traffic demand continues to be strong and is approaching full recovery to pre COVID-19 levels base.
Based on May results Global Air traffic is at 96% of 2019 levels with domestic air traffic now exceeding 2019 levels by 5% and international improving to 91% of 2019 levels. This strong recovery in traffic combined with robust airline demand for new airplanes with <unk>.
Fuel efficiency and seating capacity has fueled our recent large orders booked from airlines as a result of these orders our backlog at spirit grew from $37 billion to $41 billion in the second quarter, which includes work packages on all commercial platforms and the Airbus and Boeing backlog.
We are focused on executing the upcoming rate increases to meet the strong recovery in demand. While we are making progress there continues to be challenges in the supply chain, which have destabilize our production lines. We still see examples of distressed suppliers, even smaller ones, which have significantly disrupted our operations because of shortages.
To address.
Over the last 18 months, we have incurred impacts approaching $200 million from individual distressed suppliers and other supply chain pressures, which have been reflected in our past earnings.
These challenges in the supply chain also drove some of the forward losses recorded in the second quarter, primarily on the 787, the <unk> hundred 50, and the <unk> hundred 20 programs.
Our priority for the second half of the year remains on execution within our factories and managing the supply chain challenges to meet production rate increases.
While we continue to expect supply chain challenges, we have put plans in place to help mitigate the impacts we are spirit employees in the field working with suppliers regularly addressing rate readiness, helping them buy material extending contracts and offloading work to relieve some of the pressure.
As we've mentioned previously in our own factories, we are bringing in new employees earlier than we have in the past to help ensure a smooth transition on production rate breaks.
Expectations for deliveries on our other programs through the year are as follows 40% to 45 ship sets on 787 about 60 chipsets on the <unk> hundred 50, 580 shifts that's on the <unk> hundred 20, and 75% to 80 ship sets on the 820.
Now, let's move to an update of our defense and aftermarket businesses, which both continued to perform well toward our 2025 targets.
Our defense and space business. Once again produced strong revenue growth up 30% this quarter compared to the second quarter of 2022, the new business pipeline also remains robust and we continue to make good inroads with the defense primes displaying our design build capabilities and commercial best practices year.
Year to date, we have 120 different contracts worth more than $200 million in total we continue to bid on large defense programs and are on track to reach our target of $1 billion in defence and space revenue by 2025.
Our aftermarket business also had another quarter of solid revenue growth.
Up 15% compared to the same quarter last year, driven by increased MRO and spares volume with strong operating margins of 26% helped by some one time items.
The aftermarket team also remains on plan to reach their 2025 revenue target of $500 million.
I'll now turn the call over to Mark to take you through some more of the financials for our results over to you Mark.
Thanks, Tom and good morning, everyone.
Want to begin by discussing the two significant items that occurred during the second quarter. The 737 vertical fin attach fitting rework in the Wichita am negotiations.
The teams worked diligently throughout the quarter on the 737 vertical fin attach fitting rework related to the quality issue that we explained in April .
We're pleased to have resolved the required rework on available units in Wichita within the $31 million cost estimate we discussed on the last earnings call.
We recorded a contra revenue charge of $23 million in the quarter to account for a potential claim from Boeing related to our estimate of the repair work to date at their facility, which we believe represents about half of the units. However, I want to emphasize that any potential claim we may receive from Boeing could be materially different.
From our estimate.
Now as it relates to the I am I am negotiations and strike disruption affected all of our programs at the Wichita, Kansas site, which.
The 737 program was mostly impacted financial impacts during the quarter included $28 million of charges in the estimates primarily related to higher employee benefits.
Including wages from the new iam contract as well as strike disruption charges of $7 million and higher excess capacity costs.
Additionally, as we look ahead over the life of the New Union contract, we are forecasting labor cost to be approximately $80 million more on an annual basis.
This will put pressure on margins going forward. In addition to the broader inflationary pressures we are experiencing.
With the quality issue resolved in our factory and a new labor contract in place our entire focus is directed towards executing on our customer commitments, including the upcoming production rate increases.
Now let me take you through the details of our second quarter financial results. So let's move to slide two.
Revenue for the quarter was $1 4 billion up 8% from the second quarter of 2022.
Second quarter 2023 revenue was impacted by disruption from the vertical fin attach fitting issue as well as the iam work stoppage the year over year improvement was primarily due to higher production on the 737, and 787 programs and increased defense and space revenue, partially offset by lower production on the <unk> hundred 20.
Ram.
The defence and space segment had a strong quarter with top line growth of 30% increasing revenue by about $45 million.
Also aftermarket had a robust performance with 15% revenue growth and 26% margins overall deliveries for the quarter increased 8% on a year over year basis.
Now, let's turn our attention to EPS.
We reported earnings per share of negative $1 96, <unk> compared to negative $1 17 in the second quarter of 2022.
Excluding certain items adjusted EPS was negative $1 46 <unk>.
Compared to negative $1 21 in the prior year.
Operating margin decreased slightly to negative 9%.
Compared to negative 8% in the same period of 2022, driven by higher changes in estimates as well as the potential customer claim that I discussed in my opening remarks par.
Partially offset by the absence of losses related to the Russian sanctions.
<unk> during the second quarter of 2022 and increased aftermarket earnings.
Second quarter Ford losses totaled $105 million, an unfavorable cumulative catch up adjustments were $22 million.
This is compared to $64 million of forward losses, and $8 million of unfavorable cumulative catch up adjustments in the second quarter of 2022.
The current quarter Ford losses relate primarily to the 787, <unk> hundred 50, and <unk> hundred 20 programs.
The 787 forward losses of $38 million resulted from the new Union contract as well as increased supply chain and other production related costs the.
The <unk> hundred 50 charges of $28 million were primarily due to increased costs related to production rate recovery efforts, including freight as well as unfavorable foreign currency movements.
And the <unk> hundred 20 loss of $27 million was driven by higher estimates of supply chain costs and unfavorable foreign currency fluctuations.
Additionally, the unfavorable cumulative catch up adjustments relate primarily to the 737 program, reflecting increased labor costs.
From the Iam Union negotiations as well as higher supply chain costs.
Other expense in the second quarter of this year was $10 million compared to other income of $35 million in the prior year.
This variance was due to gain recorded in the second quarter of 2022 of $21 million related to the settlement of the repayable investment agreement with the UK Department of business energy and industrial strategy as well as lower pension income and higher foreign currency losses recognized.
In the quarter.
Now, let's turn to free cash flow.
Free cash flow usage for the quarter was $211 million.
Cash usage increased compared to the same period of 2022% largely driven by the negative impact to working capital, resulting from the rework and disruption related to the quality issue.
And the iam work stoppage as well as preparation for the third quarter of 737 production rate increase.
Second quarter 2023 cash from operations was also included customer advances of $50 million as well as an excise tax payment of $36 million related to the termination of the pension value planet.
Looking ahead, the new Union contract was in line with our 2023 free cash flow expectations. However, the work stoppage, resulting from the work stoppage led to fewer 737 deliveries that will not be able to be made up in the back half of the year. We now expect full year 737 deliveries to be in the range.
A 370 to 390 units.
Additionally, during these periods of disruption, we continue to receive materials and inventory to support our own supply chain, which caused additional pressure to free cash flows.
These items in combination with additional forward losses taken during the quarter will negatively impact full year cash flows.
Given these headwinds we are now expecting our free full year free cash flow to be in the range of negative $200 million to $250 million.
This updated range includes the benefit of $100 million of customer advances, which I will explain in more detail on the next slide.
With that let's now turn to our cash and debt balances on slide three.
Yeah.
We ended the quarter with $526 million of cash and $3 9 billion of debt.
As I discussed in our last earnings call as part of our subsequent event discussion we entered into agreements during the second quarter with our customers to provide cash advances.
As a result, we will receive $280 million this year of which $230 million was received in the second quarter and $50 million will be received in the fourth quarter.
We plan to repay these advances with payments of $90 million in 2024 and $190 million in 2025.
180 of these advances will receive from Boeing and are categorized as other liabilities on the balance sheet and reflected as cash from financing on the statement of cash flows.
The remaining $100 million is categorizes advances on the balance sheet and reflected as cash from operations and therefore included in free cash flow.
Receiving these advances will help provide additional cushion as we incur the near term financial impacts from the lower 737 deliveries and the buildup of inventory for production rate increases.
We continue to have access to public financing markets.
And we'll be looking at all available financing options to address our 2025 debt maturities as.
As well as our overall liquidity.
Next let's discuss our segment performance starting with commercial segment on slide four.
In the second quarter of 2023 commercial revenue increased 5% over the same period of 2022.
Due to higher production volumes on the 737, and 787 programs, partially offset by lower <unk> hundred 20 production.
Commercial revenue was negatively impacted by disruptions from the vertical fin attached fitting issue and the iam work stoppage.
Quarterly operating margin decreased to negative 7% compared to negative 4% in the prior year driven by higher unfavorable changes in estimates in the current period and the potential customer claim offset by the absence of losses related to the Russian sanctions recognized during this.
Second quarter of 2022.
The changes in estimates during the second quarter, which I previously discussed included forward losses of $102 million, an unfavorable cumulative catch up adjustments of $16 million.
In comparison to the second quarter of 2020 to the.
The segment recorded charges of $59 million of forward losses, and $8 million of unfavorable cumulative catch up adjustments.
Additionally, in the second quarter of 2022 in relation to the sanction Russian business activities. The segment recognized net losses of $24 million.
Okay.
Now, let's turn to defense and space segment on slide five.
Defence and space revenue grew to $190 million or 30% higher than the second quarter of last year due to higher development program activity and increased production.
Operating margin for the quarter decreased 6% compared to 9% in 2022, primarily due to increased cost on the P eight and.
And the KC 46 tanker.
Resulting from the Iam Union negotiations and higher supply chain costs as well as one time charges on the Sikorsky CH 50 <unk> program.
The segment recorded forward losses of $3 million unfavorable cumulative catch up adjustments of $6 million and excess capacity cost of $1 million.
Compared to foreign losses of $4 million and excess capacity cost of $2 million in the second quarter of 2022.
For our aftermarket segments segment results, let's turn to slide six.
Aftermarket revenues were $92 million up 15% compared to the second quarter of 2022, primarily due to higher spare part sales and MRO activity.
Aftermarket growth continues to be supported by the global recovery in air travel and is on track to meet the plan for the year.
Operating margin was very strong for the quarter of 26%.
However, don't expect it to continue at this level going forward.
The increase compared to the same period of 2022 was primarily due to higher margins on increased activity the absence of Russian sanction losses.
Ignites during the second quarter of 2022, and a onetime benefit that will not repeat of $2 million.
Despite the recent challenges we believe we are moving in the right direction going forward. We are focused on the long term trajectory of our business. Our top priority is on the execution and stability in our factories with rate increases in the back half of this year as well as in 2020.
For 2025.
Supply chain remains very challenged but we will continue our efforts to mitigate the impact of improved predictability as the industry continues to recover.
There is work to do but demand is strong and we are working hard to restore our operational and financial strength.
Now, let me turn it back over to Tom for some closing comments.
Thanks, Mark in summary, commercial aerospace demand is strong and we are on the best platforms to take advantage of this demand.
We worked through two recent challenging issues in the second quarter with the iam contract and the vertical fin attached rework and Wichita.
We expect that there will be continued challenges associated with the supply chain and stabilizing our factories going forward, we are making prudent investments in applying resources in the right places to help mitigate these challenges our focus in the back half of the year is on executing our production rate increases across all programs. We expect these actions will help enable.
To drive sustained improvement in cash flows going forward with that we'll be happy to take your questions.
As a reminder, if you'd like to register a question. Please press star followed by one in your telephone keypad. If you changed your mind. Please press star followed by two am please ensure you're on mute when speaking.
I would also ask participants limit themselves to one question each.
Our first question comes from Myles Walton of Wolfe Research most of the line is yours.
Thanks, Good morning, Hey, Marc maybe you can start with the free cash flow I think when I adjust for the the advance you lowered it by about $200 million in it.
We certainly have some discrete items I guess I was thinking might add up to $100 million post the 200 million. So maybe you can just walk us through maybe a little bit more discretely the elements of that 200 million revision.
Sure Myles Hey, good morning, good to hear from you.
Yes.
I think the big impacts really.
I've tried to cover it.
First and foremost with the work stoppage and in Wichita.
Had an impact on deliveries.
And obviously 737 is the most significant program we have.
But there are a few deliveries that will fall out of the year on our other programs as well the work stoppage happened on essentially June 20th and so theres going to be some.
Some of the deliveries that we won't be able to make up there is the cost of that disruption.
We're taking on more inventory to support the rate increase in the back half of the year and we continue to bring on more inventory.
As a mitigate or for some of the challenges that we've seen.
In our supply chain I would also tell you that if you look at our forward loss additional.
Loss charges that we booked both in the first and second quarter, that's going to put pressure on cash in the back half of the year. So really I think to summarize at a lower Boeing deliveries led by 737.
US taking on more inventory.
To protect the production system and then higher forward loss charges that we booked that we will end up.
Having a negative impact on cash and I think those will be.
We'll put us within the new guide that we have here.
And the goal really is to set this guidance for you deliver on this and make sure that we meet the cash flow targets that we've provided to you and Mike I'd just add one other way to look at it which is where we are right now in the year in Q1, we had a negative 69% in Q2 was negative 211.
That put us at negative $2 80, and our goal is to be essentially breakeven in Q3, and Q4 and as Mark said the next $50 million from the customer advance is going to be treated as cash flow. So that would put us at $2 30, which is right in the middle of our range of negative 200 to $2 50.
Our next question comes from Ken Herbert of RBC capital markets. Ken. Please go ahead.
Good morning, gentlemen, Mark this is Steve <unk> on for Ken Herbert.
Coal, we had discussed about 75% of the 250 aircraft in Boeing's inventory of potentially another 500 in the field.
<unk> has completed the rework on about half of those and the contract revenue about is for $23 million. This implies a cost of about 67000 per aircraft, which is about half of what you guys had said it was last quarter for yourselves.
Is this a fair way too is it fair for us to think that the 23 should effectively double or can you give us a little bit more color on the number of aircraft.
He has identified or the cost to them.
Yes, no that's.
Ken So theres a few things that.
Let me highlight and go through it.
We think that they've repair at about half the units that they need to repair so call it 73 or 74.
So that is a little bit less than the 75% of the $2 50. So it's really the 73 that they've repaired the $23 million.
Repair estimate aligns to that.
And so we've tried to make some conservative estimates and it's just based on the units that are at Boeing nothing in the fleet.
So our view is that as our understanding of the current disposition and the fleet is we don't expect any material impact for units in the fleet. So the $23 million only represents the units that are at Boeing and yes. It represents half of what we think is going to need to be done eventually.
But that was the best estimate we could make and so we took the charge based on the low end of that estimate.
Yeah. So I think if you if you do the math on that you get a significantly different number than the new quoted on the repair cost per unit right.
Yes, I think you have that wrong.
Our next question comes from David Strauss of Barclays, David The lawn it's yours.
Thanks, Good morning.
So the updated free cash flow forecast I mean, you've got in terms of nonrecurring pauses you got $100 million advances you've got the $180 million.
Q1 pension benefit so apples.
Apples to apples, it's kind of a $500 million burn. This year is there any way to bridge stole a positive free cash flow in 2024.
Well I mean, the simple answer is rate increases primarily on the 737.
Can also help the back half of this year as I mentioned, we're basically moving to 42 aircraft per month cycling in August .
And we will continue at that rate for the rest of this year and then next year that'll be our starting point. So the improvement in cash flow is really going to be delivered.
Delivering more aircrafts, primarily the 737.
And also then David.
We won't need to build.
As much inventory spare parts as the <unk>.
Stores inventory is the supply chain continues to get healthy. So we're there's no doubt we're taking on a lot of inventory at this point in time to prepare for those higher production rates to drive stability. So as Tom said I think the two primary drivers are.
Higher deliveries, which will generate more.
More gross profit which generates cash.
The higher production rates will help us absorb more excess cost and thats cash costs that will be mitigated and then the third component is.
Getting to a much better places it relates to inventory.
And getting past some of these one off forward loss charges that are putting additional pressure on the current year cash flow.
Okay, a quick quick follow up on the.
On the Max rate can you just reconcile I think Tom you said you are still breaking a 42 here over the near term, but your implied second half of the year delivery guidance is it looks like it's averaging kind of 35 amongst so can you just reconcile that and as Boeing or is there enough and buffer stock.
At this point.
Given what it looks like your shortfall relative to boeing's rate.
Now Boeing that to hit the 38 a month.
They are now trying to trying to achieve.
Right so.
You are right. If you just do the math if we're at a 169 units delivered to date and you take the midpoint of our of our guidance on $3 70 to $3 90 to 380 that would imply 211 for the back half of the year for six months, which is 35 per month, but the way I would say it is we're cycling at 42. So we've got the head count in place.
We've got two full lines each producing 21 aircraft per month. So we are cycling at 42 per month. The reason, it's a little bit less than <unk> 42 in the back half of the year. It's just unscheduled days. So M days that we are actually building. So you think about labor day Thanksgiving day after Thanksgiving and so forth. So there is several unscheduled days.
And then in addition to that we will be firing blanks through the production line as we normally do to increase surge capacity and just provide some some cushion into the production. So that's why the average is 35, but we are cycling now at 42 per month, we will end the year at delivering at 42 per month and that will be the starting <unk>.
For next year in terms of the buffer.
As you know we built up buffered during the period of time when the Max was grounded and we were still building at 52, a month and delivering to Boeing at 42 per month.
The good news is that that buffer came in very handy during both the vertical fin issue and the strike we were able to deliver more units from buffer to help minimize the disruption to Boeing and.
And so the buffer has gone down, but we still have about 50 to 55 units in Wichita and then there are some others that are held up in Seattle.
Some of those units are for customers that arent going to deliver in the near term like for example for China.
But the buffer is still performing a very valuable function to ensure that we can meet boeing's production rates as they go up and as we go up.
Our next question comes from Seth Selekman of J P. Morgan Seth. Please go ahead.
Hey, Thanks, very much good morning.
When we look at the.
Good morning, when we look at the continued.
Forward loss charges on the <unk> hundred <unk> hundred 20, and and spirit kind of having to absorb the supply chain challenges. There I guess, when we think about Airbus as a customer.
It seems like spirit is losing money there will continue to lose money there for a while.
And we know from what Airbus says that they plan to continue to make structures.
Our core internal capability for them I mean does it at some point is this is this is not sustainable to continue working with them.
Yes.
Well, Eric with Airbus.
Okay.
Yes.
Yes, yes, so thanks Seth.
I'd say this is Airbus is a valued customer.
They are one of the two big commercial manufacturers of aircraft in the World and it's very important that spirit has an aerostructures provider supports them as well as Boeing and also expands into defense. So I would say Airbus is an important customer and we want to continue to develop and further that relationship.
But I'd also say that Youre, absolutely right. The <unk> hundred 50, and the <unk> hundred <unk> have been very challenged programs and have been in forward losses.
And as we look broadly in the industry and air traffic is recovering as I said in my remarks, there's obviously huge strong demand for aircraft and we saw that at Paris, which was actually the third highest air show ever in terms of orders so very high demand for aircrafts and yet we're here in a very supply constrained environment.
And it's really important for the entire aerospace industry value chain to be financially healthy during this period, particularly as we go up in production rates.
And so.
The way, we see it is that suppliers, including spirit.
Are experiencing inflation in materials, and logistics and utilities and labor you just saw our increased labor costs are going to add about $80 million of cost per year and on top of that there is heightened expectations on quality and fluctuating schedules. So all of these things are driving higher costs and programs including on.
Our on our Airbus programs <unk> hundred 50, and the 220, but also on our 707 program with Boeing.
And these are important issues at the Oems will need to address in the long term and these are important conversations that we're having right now with our customers.
Okay. Thanks, Thanks very much.
Thank you.
Our next question comes from Robert Spingarn of Melius Research. Please go ahead.
Hi, Good morning, just a clarification and then a question on margins, but Tom when you just in terms of the vertical fin issues and the installed fleet I think you and Mark you said you haven't established.
Establish that that exposure is it because there isn't any or we're not there yet the inspections haven't occurred.
Don't have a way to do that that's the clarification and then mark.
Since March 'twenty, two if we go back to the Investor Day back then.
You talked about a 16, 5% segment margin free cash conversion of 7% to 9% of sales when the 737 gets to 42, Tom you just said, you'll you'll exit the year at that level, but a lot of things have changed since then interest rates higher inflation and now this new iam deal that's $80 million more.
So we bake all of that and how do we think about your margins.
Factoring those those various things yet.
Yes, so on the vertical fin, let me say it this way so it's very clear.
Just on the disposition as we understand it for the fleet.
We do not expect that there will be any material financial impact to spirit.
Based on that that disposition.
Okay. So we don't expect any because theyre actually omnichannel financial impact.
Because they don't need to get there.
Great.
The the <unk>.
The disposition will work, we don't expect there to be a financial impact a material financial impact for spirit.
Okay.
That disposition is still being finalized but that is our understanding of it as of right now and Thats, how we are communicating it.
Yeah.
Okay. So with regard to the second part of your question.
16, 5% margins in the 7% to 9% free cash flow conversion when we get to 42 aircraft per month. Obviously those were made before this hyperinflationary environment before a new labor contract before a lot of schedule changes before a lot of different expectations in terms of how we build the aircrafts and so.
What we would say now is yes, there is more pressure.
Once we get stabilized, we'll revisit and determine what those projections will be for the future, but obviously right now there's more pressure because those estimates were made before a lot of what we know today are Kurt.
Okay, and then just on the $80 million what size.
The business does that contemplate is that where you are now is that a cost when things stabilize.
What production.
Volume.
That it's.
It's based on what we are currently at and what we project over the next four years of the term of the contract yes. So Rob that it's an average obviously, it's a little lower today will.
We will be hiring more people over the next couple of years as rates go up but that is an average over the four year period, So a little lower today higher in year three or four.
Okay. Thanks for clarifying appreciate it.
Okay. Thanks, Rob.
Our next question comes from Sheila <unk> of Jefferies. Please go ahead.
Good morning, guys.
And just wanted to step back from that cash outflow.
And maybe specifically focusing on the Max contribution in 'twenty three 'twenty four 'twenty five.
Obviously work stoppage as positive.
Warm agreements change the free cash flow profile of the Max and 23, how do you think about that in 'twenty four 'twenty five and how does the inventory depletion paragraph.
Yes, so Sheila I'll I'll answer first and then let mark provide a little bit of detail, but the first thing is you're right in 'twenty three the work stoppage did impact us and we lowered our <unk>.
Our guidance in terms of the deliveries for the Max is as a result, but the good news is is that we do now have our contract in place with the Iam and it's for four years and we're satisfied with that it's a very competitive contract.
And it reflects the gratitude that we have to our iam colleagues for their contributions.
So it impacted 23, but as we go into 'twenty four and 'twenty five we have stability now on that front and we will be able to execute on our rate increases and the rates that we expect to be delivering and those will be higher. So as I said, we are already moving to 42 aircraft per month in terms of what where were cycling will end the year at that and that will be.
The starting point for next year, and we do expect that we'll have at least one rate increase in 2024 as well over the 42 so.
So if you lay that out because the Max is our biggest program and deliveries are going to be going up is that we will drive more free cash flow and now we have a more stable environment with the contract in our rearview mirror.
Yes, Sheila good morning, I think the thing that I would add is.
The quality issue in the vertical fin the work stoppage.
That caused significant disruption to us significant right.
And it was obviously not planned at the start of the year.
Much lower deliveries in the second quarter, we've had to add more people.
We're taking deliveries out of the plan.
It had serious impact overall cash flow projections for the year.
And as we move into 2024, we move past the work stoppage, we move as Tom said, we move pass the quality issue.
It's all about execution, it's about.
Stabilizing supply chain and.
Producing on time in our factories and meeting our delivery commitments on time right and so the positive cash flow is all 100% based on the further stabilization supply chain and in meeting our production commitments internally.
And if we can go do that we'll see a significant improvement in overall free cash flow and Thats, what we have to do operationally, we've got to execute we've got to execute better and that will lead with the higher production rates too much better profitability and cash flow.
So how does that change just like your free cash flow margin.
Per aircraft on the next slide.
If it was close to 20% before does it lower at 500, Bev I'm thinking like instead of one two per Max Youre down $10 million with all these changes.
Well I'd say this year.
We tried to be really really granular.
As it relates to the impact that I would tell you. When you think about as you just said the cash per unit. The biggest driver as we look forward on the 737 as the impacts of the iam contract.
You know that it's over 50% of our revenues as a company, but much higher than that as it relates to Wichita.
And so I think that you can put some math to the negative impacts of the higher cost and the pressure that's going to put on our overall business and a big portion of that is going to hit the 737.
The way I would also say it is as we've said before as you always have to run fast in this industry to stand still we're always facing pressures we knew the iam contract was going to create additional financial pressure and it did and.
And we need to continue to work to mitigate that through our productivity initiatives.
Great. Thank you.
Thanks, Sean.
Our next question comes from Doug <unk> of Bernstein. Please go ahead.
Yeah.
Thank you and good morning.
Good morning, I wanted to.
Morning, I wanted to go over to the wide bodies and when you look at the 787 and the <unk> hundred 50 and can you.
Tell us what the rates are you are at now and when you look forward you have Airbus.
Handing by producing nine a month at the end of 2025 Boeing on the 780 710, a month in 2020 526, now where are you now and how do you get to those high numbers.
Right well.
As it sits right now Doug both on 887, and 350 were really at about five per month right now in terms of what we're delivering at and so as I mentioned in my remarks, we're going to deliver between 40 and 45 80 Sevens this year and about 60, or so <unk> hundred fifty's, but the rate right now on both program.
So it's about five.
Now Boeing has said they're going to go up to highest 10 at the end of 'twenty four and Airbus has said I think high as nine in 2025, which would include some freighters and so the way we get up to those rates, we have already the capital because we've been up as high as 14 on 787.
Now there is some more pressure on the build process because things have changed the the fit and finish issue on 787 and the pull up for US. It has resulted in some change in the build process.
Which puts some pressure on it but we have a lot of the capital and tooling to get up to 2014, and so it's really a question of adding the head count and making sure we adjust and take into account some of the changes in the build process and thats. How it will happen on 77 <unk> hundred 50 were capitalized for 13 aircraft per month, and we've been as high as 10.
And so obviously we are at a much lower rate right. Now there are some differences there in terms of bill process as well, but it's really a question of hiring the people in our Kinston plant in our Saint Nazaire plant to increase the rates to what Airbus is expecting the other thing I would say, though is the freighter, which is in development right now is going to be us.
<unk> different aircraft I mean, it's a derivative, but there's a lot of changes to it and so that will also put a little bit of pressure on the system.
It's kind of a version of the 10.
And so that so that creates another minor minor model mix, let's say, so some additional complexity but.
The capital is in place to get up to rate nine as Airbus is expecting and we just need to start hiring the people at the right time period. So that they are ready to meet those rate increases.
What should we expect then we shouldnt expect any additional capital investment requirements, but next year.
Trying to dimension.
Pressure that this ramp up from.
From a staffing standpoint.
What is that going to suggest in terms of just pressure on your margins and cash next year.
Yeah, well since both of those programs are in forward loss.
<unk>.
The normal type of pressure.
We've built into our projections in the out years, the increase in head count to support higher rates, but you also get the benefit when you have a higher rates of course of better fixed cost absorption and so that will be an offsetting benefit but I'll just get back to what I said.
A little bit earlier.
When when Seth asked the question about the forward loss charges is this is an industry wide problem and in a kind of very high demand environment, which also has supply constraints. It's important that the all the suppliers are healthy and suppliers are incurring higher levels of cost inflation.
And material.
As well as labor logistics and utilities.
And this these do have to be addressed in the long term and these are the conversations that we're having with our OEM partners.
Okay. Thank you.
Thanks Seth.
Our next question comes from George Shapiro of Shapiro Research George The line is yours.
Yes, good morning.
Mike just.
Clarification, the $80 million you said was an average I mean, if I look at the wage changes.
Go up like 11% from 23 to 25, so that just assume that that $8 million was really like a 2024 number ex forgetting the people you've got a hire that was just kind of the average wage per individual right.
Yeah, it's probably about right George.
Okay, and then one other quick clarification.
What is different between the agreement you have on the advance from Boeing versus Airbus that lets Airbus be counted as free cash flow and Boeing is financing.
Sure George so the.
The main fundamental difference between.
$180 million advance from we got from Boeing in the $100 million from another customer is.
The Boeing advance is paid to us we've collected that money and we make a onetime payment to Boeing in the first quarter of 2024 of $90 million, just a payment to them.
Like like paying back a bank.
And we do that in 2025.
The other customer wanted its structured differently at the end of the day.
Their own for their own reasons, and so we're paying that one back.
In a per ship set quantity in 2025, so essentially we're paying it back in 2025, So I think the other way you can look at it it's a prepayment.
That we received $100 million against deliveries that we're making in 2025 and so from a ASC 606 accounting standpoint that results in us work that requires us to treat that as in cash from operations.
As a as an advance.
And so again, it's really more of a technical accounting item.
At the end of the day, it's not operational but technical accounting wise.
And us having to have to treat it in 2023 is favorable to free cash flow and in 'twenty five.
That will be a negative impact of free cash flow in 2025.
Okay very clear thanks very much.
Thanks George.
Our next question comes from Cai von <unk> of TD Cowen caller. Please go ahead.
Yes, thanks, so much so.
Two questions on cash flow first.
Three seven build is a big plus.
Page seven entry system.
<unk> tried to our basic users so as those rates Phil what is the incremental build in terms of the forward loss.
And then secondly, because you have the Boeing repayments are below the line.
<unk> been able over the period of $24 25 to reduce your debt.
Yes, well, let me just address the forward loss issue.
As you said on 737, the impact will be positive on 87 and $2 20 in terms of the forward loss, we've taken into account.
The projections in terms of the schedules going forward going up so.
That is all been taking into account in terms of the forward loss.
In terms of the.
The Boeing payment being below the line.
Okay.
That that is how it is but what was the second part of your question then Cai the second part.
Well I mean, so with those three programs building, presumably the cash as you move forward increases that's why we took the forward loss and then you do have the Boeing payments and you have the cash payment to Airbus at least.
The cash that you don't get so over the two year period.
To reduce this debt.
Yes.
Yes.
Jump in real quick so I think.
First off we do have lossmaking programs, we talk about those I would tell you that.
The amount of burn on those cash flows forward loss programs in 2023 will be higher than 24, right, even though we're going to produce more than 2004.
We started the ramp up on 787, we didn't restart production until August of last year, and we had a lot of units as we slowly started to go from one to three to five lot of higher cost way up on the learning curve. The bill process changed so we're seeing a abnormally high cost per unit.
Build on 787 in 2023, and Youre seeing some of that reflected in additional foreign losses that we booked in the first and second quarters.
Very similar on <unk> three <unk> hundred 50, as we recovered the production plan.
From an overstaffing standpoint to recover that expedited boats that is all putting additional pressure what I would call cash per unit on the lossmaking programs in 2023, and then as we move into 2024, what should happen as were moving down we've got more stability in those factories.
Higher rates will help us absorb more fixed costs some of the pressure that we saw in 2023 will abate as we move in 2024, there's still loss, making programs <unk> hundred one it goes up in rate a nice little tick up in 2024, which will help so I would say when you think about cash between 23 and 24, yes, theres cash consumption.
On the loss, making contracts in 'twenty, three and there will be on 2024, but I would tell you based on our what we believe today it will be less impactful in 'twenty four 'twenty three and so when you think about cash flow. The next couple of years.
Obviously the issues around the quality issue in the strike has moved the cash flow generation a bit to the right and therefore, we won't be able to generate significant cash flow in 'twenty four 'twenty five there'll be some cash that we're able to generate which we'll use to pay down debt.
As best we can as we move through that and so really that's the game plan I think more burn on the forward loss this year, a little bit less next year and as we move into 'twenty four 'twenty five and we move to cash flow positive, we will use that cash flow to pay down debt.
And that's part of that overall, when we think about our overall financing strategy and liquidity strategy on how we're addressing our debt and our cash balances and kind of what I would say about that is we will use the excess cash and $24 25 to start to pay down debt, but we have a big chunk. That's due in April of 2025.
We are not going to be able to generate enough cash to pay all of that off. So we are going to start to look at some refinancing options and we'll consider all different types of options as Mark said in his his comments.
As we look to refinance that 2025 debt.
Very helpful. You mentioned.
The price hikes, one of the messages from Paris was that pretty much everyone is asking for and most people aren't getting price hikes do your forecast and your comments assume any price hikes.
No they do not.
Not at this time thank you.
Yes.
Thanks Cai.
Our next question comes from Kristine <unk> of Morgan Stanley Kristine The line is yours.
Thanks, guys.
So in terms of a follow up to Seth's question.
Question earlier, I mean aerospace is still largely duopoly and therefore, both Boeing and Airbus important customer, but <unk> got programs like the 787 and the <unk>.
The negative free cash flow for over a decade, now and you've got additional pressures with 820 and even defense.
With costs continue to increase with labor and supply chain still kind of graduated from spot I mean morphine.
Favorable.
What point do you go back to the customer I mean, despite the important.
And renegotiate pricing and if they're not willing to negotiate like what's your walkaway point of returning some of these programs back to Rob.
Your customers.
Well Kristina you raised very good points and it's it's a situation that exists both on the commercial side and on the defense side with the large primes is.
Impact of inflation, especially when you have a fixed price contract has an impact and as I said, it's a broader industry issue.
In terms of the fact that there's a huge demand out there right now is air traffic recovers, but theres all these supply constraints and there's pressures on the supply chain in terms of inflation in material and labor logistics and utilities newbuild processes fluctuating schedules and so I would say the the issue is we are under contract.
And we are going to meet our contractual commitments to our customers, but really the Oems and the U S government from a defense standpoint, do you have to recognize the environment has changed and it's a highly inflationary environment and these are very important conversations that we have to have with our customers.
Thanks, guys in terms of.
We're doing some of that pricing alleviation I mean, we're hearing some of your peers, they are getting better pricing and actuation, where even the jet engine supply chain is there something different.
A long term agreement that make it more difficult to get that price increase.
Our long term agreements are typical.
Typical I would say the industry. They are requirements contracts. We are fortunate that we have these contracts that are life of program usually sole source and these are extremely unique contracts and around all of the best programs. I mean, if you look at the 737, we make 70% of the structure on the $3 seven for Boeing including the entire fuselage.
The $3 20, we make about 60% of the structure for the win with Airbus.
We have a huge work package on the <unk> hundred 50, with the center fuselage and the fixed leading edge and then on the $2 20, we make three sections of the center fuselage the entire wing, including all the systems and we make the pilots. So when you think about the industry in narrow body aircraft being so important.
We have the biggest work packages by far on the narrow body programs, it's 85% of our backlog. So we feel very fortunate that we have those positions on those contracts.
So that there has been a big change in the environment with inflation.
Both the material and labor utilities and in logistics.
Bill processes different rates that are still lower than we were overall back in 2019 and so.
Those are realities and and the Oems are fully aware of it and as I said. These are discussions that that we need to be having with the Oems at this time.
Thank you very much.
Our next question comes from Michael <unk> of <unk> Securities. Michael. Please go ahead.
Hey, good morning, guys. Thanks for thanks for the question I guess, just staying on Christine's point.
With these contracts that you are posting the best programs, but seemingly youre, just not getting compensated or paid for the value, you're providing and I guess.
You are saying some of these things have to be addressed.
How receptive are Boeing and Airbus and their sense of urgency.
Thank you can get something changed here in the shorter term to capture some pricing.
And then I guess, maybe even.
You still have I guess the price step downs as you go up in volume. So I mean is that something that you are looking very closely at I think if.
You can remind us I think 42 with sort of the optimal rate for the 737, but once you go above that youre going to start getting price step down because it just seems like youre getting squeezed from all sides here and maybe there should be more urgency.
Okay, I get it running running fast to stay still but it doesn't really sound like a good proposition for shareholders.
It's a challenging environment and I think we all recognize that.
It's much more inflationary.
In material and with these new labor contracts now you see that in labor as well and as I've said.
It's an industry wide problem because demand is clearly there the orders are coming in production rates are going up.
But all suppliers are facing challenges with these higher level of costs.
And so it is an important systemic issue that the Oems do need to address and it's important that we have these conversations with them and I can't put any sort of timeframe on it.
Discussions like these are always difficult and challenging.
But it's something that we are prepared to have for the reasons that you just outlined yeah, Michael I would just add to just try to be clear.
There is a sense of urgency by the management team here.
<unk>.
We hear you we understand.
<unk> got a lot of work to do on this end.
Got it alright. Thanks.
Thank you. Our next question comes from Ron Epstein of Bank of America. Roland. Please go ahead.
Hey, good afternoon, good morning, guys.
Good morning, Ron maybe maybe.
Maybe the elephant in the room I'll, just I'll just bring it out people have been sort of beating around it.
Is there a fundamental change that you have to make and spirits business to make it less volatile.
Just more predictable because it always seems like you guys ended up.
The tail of the whip.
Hum.
<unk> hundred 20, 707, they're great programs like Michael said.
But.
They don't seem to be helping you right now, although they're helping the narrative.
Yes.
You must I mean, if you can give us some feeling for.
Or how youre thinking about strategy and how you could change spirit to.
To make it a more.
I don't know if a viable but less of a volatile.
Business.
The public markets could.
View easier right, because where things swing on all over the place. It seems like you guys always ended up with the short end of the stick.
And that just doesn't seem fair.
Yeah, So as I said, it's a challenging environment right now.
And on a narrow body contracts we have.
So source life of program and where you have great work packages and those rates are going up.
The challenge has really been on some of the wider body contracts and more of our composite programs. So if you look at the three programs that are in forward loss. The 87 to $3 50, and the $2 20 of those are all composite programs and that has been more challenging we've not come down the learning curve as fast as we all thought we would when they first started and so we do need to.
<unk>.
The conversations about how we address that given the inflationary environment that we're in but let me see you said what can we do to improve and change fundamental changes in spirit a lot of it is in our production system and these are investments we've been making over the last three or four years during the pandemic to improve the flow of our factories.
Digitization and automation and robotics and drive quality in.
In a much more fundamental way and those are going to start to pay dividends as we as we go up in rate. So you will see that the other broader thing I would say you said about strategy is when we went into the pandemic. We were too concentrated we were 95% commercial where 98% original equipment, we were about 75% Boeing and 50%.
Our revenue came from Max we were too concentrated and so we've made a concerted effort over the last four years, including during the pandemic to start to diversify.
And that diversification a big part of it was the acquisition we made from Bombardier in Belfast, Morocco in Dallas to give us more Airbus content to give us twice as much aftermarket and four times as much business jet and so the diversification will start to pay dividends over time as we've said we want to be.
$1 billion in defence by 2025, we want to be $500 million in aftermarket by 2025, and so those are some of the things that we're doing to fundamentally change spirit is improving the factory and delivering productivity through all of the different advanced manufacturing initiatives I said, having discussions with the with the Oems.
The composite programs and the material system and the challenges that we've incurred overtime and then continuing the diversification of spirit. So that we're less concentrated in the future with a broader exposure to defense and space as well as aftermarket.
And if I may as a follow on.
We looked at Belfast specifically.
Has that created any value I mean to this point and when would you expect it to do so.
It's where we expected it to be rates are a little bit lower and that's driven some of the forward losses, but when we did the program. We knew it was going to be a challenge we took a purchase accounting charge of about $375 million through 2025, and we expected that the rates would get up to.
<unk> thousand 14, or 15 by the middle of 2025, now that could get pushed out but that's still what Airbus is saying the <unk> hundred 20, we think is a great program.
It is 100 and the 300 right now take it from about 100 passengers up to 150 passengers, it's Scott a brand new engine and the geared turbofan.
It's a lightweight fuselage and it's a fully composite wing all of which we make.
And so it is a very efficient aircraft. The airlines do like it I know, it's had some operational challenges, which they are working through and they'll get that right.
But it's a great program and someday they might extend it up too.
500, which would take it up to 170 passengers, which would increase the rate even further so we made a big bet on the <unk> hundred 20 program, we're happy with that that we think it's a great strategic program, it's taking a little bit longer to realize but in the long term. It was a good strategic move were happy we did it it is going to help diversify spirit because in addition to.
The 820 program that we got out of Belfast, We also doubled our aftermarket and we got four times the amount of business jet work. So we think it was a good deal and it will pay off in the long term.
Got it thank you.
Yes.
Our final question comes from Pizza Ahmed of bed Pizza. The line is yours.
Yes, Thanks, good afternoon, Tom and Mark Hey, Mark maybe I'll just try to end on a positive note.
Aftermarket mix.
What are the margins, where it was very strong this quarter, just any onetime to call out or was it just mix and how sustainable is it. Thank you Emma.
Hey, Thanks, Peter and good to hear from you.
We're really happy with the aftermarket.
It continues to grow.
It's hitting our revenue targets for the year, it's performing from an operational delivery performance margin perspective, and we've talked about it being a 20 plus percent margin business there are.
A couple of small things that happen in the second quarter that won't repeat when we think about the third and fourth quarter.
But the teams executing I want to congratulate our aftermarket team, they're hitting their big revenue goals for the year.
They are performing well for the customers, we continue to grow geographically and expand our portfolio.
And so we're really pleased with that and as we move through the balance of the year.
We're going to continue to drive execution and hit the 20 plus percent margins and as Tom talked about.
We're right on track 520, plus percent margins and although it doesn't.
It doesn't seem as large as our commercial business, it's going to be a nice contributor as we grow over the next couple of years. So Peter I. Appreciate you asking the question we're happy with the team we're hitting our marks and we are very very focused on continuing growing that business and making sure that it produces accretive margins.
Thanks Mark.
Thank you.
We have no further questions on the long with that this concludes today's call. Thank you for joining you may now disconnect.
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